Financial Services (Banking Reform) Bill

Public Bill Committee, 26 March 2013.

Clause 6 - PRA annual report

Greg Clark (Conservative, Tunbridge Wells)

It is a delight to see you in the Chair, Mr Bone.

We have discussed the role of derivatives in the report. Proposed new section 142J will place an obligation on the Prudential Regulation Authority to make a full report to Parliament and the Treasury every five years on the ring-fencing rules.

Clause 6(2) lists the areas that will be covered. As we discussed on Thursday, they are set at a relatively high level. However, as I told the Committee then, the Government will consider the case for specifically mentioning derivatives when we debate the Bill in later stages.

Having listened to the Parliamentary Commission, we will now require annual reporting on ring-fencing. The report will be about the way in which ring-fenced bodies have complied with the rules and guidance and what steps the PRA has taken to enforce the ring fence. The clause will amend schedule 1ZB to the Financial Services and Markets Act 2000, to include a report on ring-fencing in the PRA’s annual review.

The PRA’s annual report will have to be laid before Parliament, which will give Parliament the chance to track from year to year the strength of the ring fence.

Chris Leslie (Labour, Nottingham East)

Good morning, Mr Bone. It is always a pleasure to serve under your chairmanship. I have missed it; the last time was probably on another financial services Bill of some sort or another. I am glad to be back.

As the Minister set out, clause 6 gives the full detail of the reporting requirements that will be placed on the Prudential Regulation Authority. If we are to police the ring-fencing concept properly, it is important that we have a comprehensive and independent process of monitoring the compliance of particularly ring-fenced banks with the rules.

I have a number of questions for the Minister. I am assuming that, as well as the work of the ring-fenced banks, the PRA will be responsible for keeping track of how investment banks or associated investment banking activities in sister or parent companies interrelate with the ring-fenced banks. In other words, we will look not just at what goes on in the retail side of the bank, but at any attempts by investment banks to muscle into the business lines of the retail banks or to get involved with them. Are we talking about—this analogy is getting a bit ridiculous—policing both sides of the fence, rather than simply one side of it? How would that work?

The tests set out by the Minister are relatively clear. He has kept them fairly broad brush, rather than itemising certain aspects. As he knows, we are keen to include a specific reference to monitoring the derivatives’ activities of retail banks. We will probably return to that issue on Report, hopefully with some, more detailed rules on the arrangements.

The PRA will be both enforcer of the rules and author of some of the criteria. We agree with the provisions in clause 6, which will also cover whether guidance notes and other reports have been taken to heart by retail banks.

When can we expect the first of such PRA publications to be made? I know that the PRA does not, theoretically, exist yet—it is only a matter of days—but will we have to wait a full calendar year? I assume we are waiting until after the Bill gets Royal Assent, because the requirements are not extant at present. However, before Royal Assent I would like to get a notion from the PRA, even in an informal context, that it will be working on those processes as soon as it gets cracking next week. It would be nice to know that in the financial year 2013-14 there will be some PRA commentary about the processes as we move towards the ring-fencing arrangements. I would be grateful if the Minister could clarify that matter.

I am quite sure that the Minister is able to satisfy the Committee that the PRA will have the necessary resources to monitor ring-fencing, but I am not sure whether there will be a particular division within it tasked with addressing that set of structural questions. We have heard the general description of micro-prudential regulation, which sounds great, if slightly opaque to the outside observer; however, what will that involve? Are we talking about a set of generalists within the PRA who will occasionally be tasked with looking at the structural questions, or will there be a standing unit specifically looking at the issues of safety and division?

Finally, when we get the PRA reports, what will be the process thereafter? Will there be opportunity for parliamentary debate? Will there be a written ministerial statement or other ministerial response reflecting on the PRA’s findings? It would be useful to know what the answer will be to the “So what?” question when the PRA makes its reports. Those are the only issues that I have with clause 6 as it stands. [Interruption.]

Peter Bone (Conservative, Wellingborough)

Graham Evans? No, he does not wish to speak.

It might be helpful to the Committee to remind officials and the Minister that they should not pass information directly to one another. That is a convention of the House.

Greg Clark (Conservative, Tunbridge Wells)

I was looking forward to a speech by my hon. Friend the Member for Weaver Vale, but we will hear it on another occasion, I am sure. I am happy to respond to the points made in the debate. I can confirm to the Committee that the duties of the PRA in respect of reporting on adherence to ring-fencing rules apply, in the terms that the hon. Member for Nottingham East used, to both sides of the ring fence, so they would apply to attempts by investment banks to breach the ring fence from that side. They apply to the totality of the ring fence.

As the hon. Gentleman said, the provisions in clause 6 are relatively high level, but we will certainly see what can be done to ensure that there are specific requirements on derivatives.

On the PRA’s annual report, which is the subject of the clause, as the hon. Gentleman said, the PRA comes into effect in a few days’ time, on 1 April, and its first report will be a year after that, in 2014. However, the requirement to report on the ring-fencing rules that the clause inserts will apply a year after those rules have been introduced, so the first report concerning the ring fence will be in 2019.

On the resources available to the PRA and its internal structures for monitoring, as the hon. Gentleman knows, the PRA is operationally independent and it is a matter for the PRA to structure itself the better to carry out its duties. All I will say is that, having moved towards the twin peak system of separating conduct and prudential regulation, our intention is that there be a much clearer focus on the prudential regulatory activities.

Chris Leslie (Labour, Nottingham East)

Obviously it is true that the PRA is independent, in a way, although it is under the careful wing of the Bank of England. However, it is important that we have some form of parliamentary insight into how adequately the regulators are able to do that particular job. It would be useful if, perhaps from 1 April onwards, the Minister could provide greater information about what the PRA structure will be, so that at least we would get a sense of the adequacy of the design of that regulator. Perhaps the Minister could send a note or—to use that horrible phrase—an organogram to Members about how the PRA will work.

Greg Clark (Conservative, Tunbridge Wells)

I am happy to suggest that to the PRA. I am sure it will not be shy in wanting to assure the public, and indeed Members of this House, that it is organised in a proper and effective way. The annual report, to which the hon. Gentleman referred, will be laid before Parliament. It will be published and deposited in the Library with a written ministerial statement attached to it. It is expected that the Select Committee will call the officers of the PRA to give evidence on its annual report. The Committee can scrutinise it in that way.

Whether or not the Committee has concerns about the PRA’s operational effectiveness, it will have the opportunity to satisfy itself that the operation, as well as the rule-setting and policing side, of the PRA is adequately scrutinised. Arrangements are in place for the scrutiny of the PRA, which was much discussed in another Committee, no doubt chaired by Mr Bone, on the Financial Services and Markets Act. We are using those provisions, and the clause adds a further requirement to the reporting mechanism, which has been well scrutinised and is about to become operational—it will do so next month.

Clause 7 - Ring-fencing transfer schemes

Greg Clark (Conservative, Tunbridge Wells)

This clause gives effect to the schedule, which provides for ring-fencing transfer schemes. Such schemes allow a bank to transfer its business from one legal entity to another in order to comply with the ring fence. Currently, as we know, banks’ activities are commingled. Ring-fencing is designed to separate out retail deposit-taking and trading in investments and place them in separate divisions. That could involve moving retail businesses out of the existing body, or it could involve moving investment businesses out, or possibly both, and creating new bodies, as we have discussed on previous occasions. It is up to the Bank to respond to the requirement to ring-fence. There are a number of ways in which it can do that.

Part 7 of FSMA provides a mechanism, which requires the approval of the court, for transferring all or part of the business of banks, without requiring the approval of all those affected. For example, part 7 would allow a deposit book to be transferred—in the case of a merger or takeover—from one institution to another without the approval of every depositor.

I do not know whether it is reasonable to comment on the schedule at this point, Mr Bone.

Peter Bone (Conservative, Wellingborough)

Please keep it brief.

Greg Clark (Conservative, Tunbridge Wells)

I will keep it brief. The schedule adds another special case to the transfer scheme: a ring-fencing transfer scheme. It uses the established procedure, including opportunities for the regulator or anyone to make representations to the court, but it adds a veto to the PRA, which must approve an application to the court for a ring-fencing scheme. The PRA would be expected to use that veto if the move were incompatible with its new continuity objective to provide for the continuity of core services. For example, it could veto an artificial mix of business lines, which could mean that the business was unviable if separated.

Chris Leslie (Labour, Nottingham East)

With the leave of the Chair, I would like to talk about the schedule and the clause simultaneously. It is difficult because clause 7 facilitates the schedule to the Bill and we will be discussing an amendment to the schedule in the next group. It is slightly awkward when we have a clause that facilitates the schedule. The Minister set out quite helpfully what that schedule entailed. Obviously, the business transfer scheme arrangements are being changed to ensure that the ring-fencing provisions will be consistent with and can build on the existing rules.

I have some specific questions on the details of the ring-fencing transfer scheme that go beyond the amendment we are to discuss. The Minister said that the PRA would now have a set of powers to supervise the process. I shall be grateful if the Minister will set out the sort of questions the PRA will ask the transferee ahead of any court sanctioning arrangement.

I also ask the Minister to put an explanation on the record, for the sake of future circumstances in which this set of transfers might apply; it is difficult to envisage what and when they might be. Will he reassure the Committee that a court-based transfer process is the right one? Moving to a legal and judicial context to oversee some of these transfer arrangements brings the advantages of independence and authority. However, there have been criticisms in other business transfer cases of the sometimes cumbersome, expensive and slow nature of a court process.

Given the inherent uncertainties and slowness of a court process, will the Minister reassure the Committee that he balanced other options for transfer arrangements, and explain why the court arrangement is considered the right one? Perhaps he could also reassure the Committee about the duration of the process. Given the centrality of banking and the retail banking system to the economy and many consumers, a long-drawn-out process might cause anxieties in the market and beyond.

What factors have been taken into account when considering risk representations from people who might claim that they are suffering an adverse effect from a transfer? How will those be made in a court process? Those are some of the concerns. I can imagine a transfer process going on and a lot of people having concerns. Are they all expected to be represented in court, or will there be some other facility for those representations to be made? I assume that that would be through the PRA, as a conduit towards the court process. However, it would be useful to get a sense of those arrangements.

My final question on the schedule is how will the operation of reclaiming funds change under the reforms? The Minister will be aware that in recent years there have been a number of changes to the dormant bank account arrangements. If retail banking services are being transferred from one institution to a brand new one, individuals may discover years later that they have dormant accounts and wish to go through the reclaiming process. That would be a key downstream consequence of any transfer arrangement. It would be useful for the Minister to set out how that particular transfer scheme will not necessarily cut across the rights of long-standing account holders to go through a reclaim process for dormant funds in banks or building societies that might be subject to transferred arrangements.

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman raises the criteria that the PRA might consider in exercising its veto. Consistent with the establishment of the PRA as a body with broad powers to scan the radar for risks to financial stability in the UK banking system, the provision has been drafted not to be too prescriptive and to identify very particular grounds on which the PRA might object to a proposed ring-fencing transfer scheme. I think that that is the right approach.

We have debated the innovative capacity and tendency of the banking sector in this Committee, as have Members on the Floor of the House, and it is an issue to which these concerns particularly apply. That is one of the reasons for the PRA veto. It would be of concern if some novel device were proposed that affected the future contribution of the bank to financial stability. So the right approach is to enable the PRA to assess each scheme on its merits and to make, as it were, a bespoke assessment of whether any features of the scheme would contribute to financial instability, rather than to constrain it in anticipation of certain grounds that may be sensible now but could be overtaken by events.

I have given the example that, given that the point of ring-fencing is to allow the continuity of services, it is conceivably and theoretically possible for a bank to put into a ring fence such a mix of business lines that the organisation would not actually be viable, free-standing and independent. That is a matter of judgment on the part of the PRA, which has the ability to exercise such judgment under the clause.

We chose to use the courts to facilitate the transfer process, in order to use as far as possible the existing provisions of FSMA. As the hon. Gentleman knows, many, if not most, of the provisions in the Bill are amendments to FSMA. Clause 7 is such a provision. There is an established procedure for changing arrangements in banks by application to the courts. That has worked relatively successfully since it came into effect in the 2000 Act; there have been no particular concerns.

The courts have the ability to take into account the potential consequences for third parties—be they depositors or people who may be exposed to other parts of the bank’s activities. One of the advantages of the courts determining such matters, rather than the regulator, is that anyone affected by the consequences of transfer can make representations to and be heard in court. That procedure has been successful to date. There is of course an additional route—people can make representations to the PRA. That is a second way in which they can make any concerns known.

Quite apart from the pragmatic reason for using provisions that are currently available and have been tried and tested, there is an important reason of principle. These matters may affect the property rights of individuals in terms of where their money is held. It could be transferred from one body that they have chosen to invest in to another. So it is reasonable that, given the engagement of such property rights, the courts should be the final arbiter of such matters. In assessing claims, the courts can hear representations where individuals feel that they have been unreasonably affected by the provisions. Part 7 of FSMA is designed to minimise vexatious claims, and third parties need to give notice to the courts of their proposed representations. As I said, it has proved to be a reasonably effective regime to date.

Chris Leslie (Labour, Nottingham East)

Will the Minister deal with the point about how dormant accounts will be treated? I would be grateful if he could elaborate.

Greg Clark (Conservative, Tunbridge Wells)

Given the use of FSMA, the arrangements for dormant accounts are provided for in the regulations. The rights of account holders, whether the accounts are active or dormant, will continue in exactly the same way as they do now and the right to access to accounts, should the holders discover that they exist in future years, will be preserved.

Schedule - Ring-fencing transfer schemes

Chris Leslie (Labour, Nottingham East)

I beg to move amendment 29, in the schedule, page 24, line 9 at end insert—

‘( ) After subsection (3) insert—

(4) Without prejudice to the generality of subsection (3), in the case of a ring-fencing transfer scheme the court must not make an order sanctioning the scheme if it considers that it might lead to the dissolution of a company or to the transfer of liabilities owed to any persons in a manner that may prejudice the interests of those persons.”.’.

I do not think I will shock Members by saying that the concepts in the schedule seem rather dry. After the events in Cyprus and elsewhere, however, bank transfer schemes suddenly become quite interesting and relevant, so it is worth spending a little time discussing the issues. I do not want to go through the details of the schedule, because most of my questions have been satisfied, but the Parliamentary Commission on Banking Standards specifically suggested that an amendment was required. Under section 111 of FSMA, the court may make an order sanctioning the transfer scheme if certain conditions are satisfied, including that the appropriate certificates have been obtained and any authorisations required are in place. In addition, subsection (3) says:

“The court must consider that, in all the circumstances of the case, it is appropriate to sanction the scheme.”

Amendment 29, which was drafted by the Commission, would require an additional condition to be satisfied before the court sanctioned a ring-fencing transfer scheme. The amendment would prevent courts from making sanctioning orders that

“might lead to the dissolution of a company or to the transfer of liabilities owed to any persons in a manner that may prejudice the interests of those persons.”

What does that mean? It would implement paragraph 230 of the Commission’s first report, which states that safeguards are needed to prevent the creation of the ring fence from being

“used as an opportunity to shift liabilities…in an artificial way.”

The Commission felt that such safeguards were needed because the liability for conduct before the split would remain with the legal entity, which was responsible for the conduct in question. Therefore, if a company with outstanding liabilities was dissolved during the division into a ring-fenced or non-ring-fenced set of bodies, the liabilities might also be dissolved with it. It would be a bit like trying to pursue a double glazing or car sales company that had gone into administration; the rights of consumers to pursue a problem would be affected.

Many people have voiced concerns about such problems in a consumer context, but the liabilities of a retail bank that disappeared or was transferred might be similarly affected, so the Commission thought that it was important to establish this process. If new companies are created, they will be free from the outstanding liabilities of the company of which they were previously part. The amendment would guard against banks using opportunistic tactics during the creation of the ring fence by preventing the court from sanctioning any ring-fencing transfer scheme that posed such risks. When banks implement the ring fence, they will almost certainly require the courts to sanction the scheme, so limiting the circumstances in which the sanctioning orders can be made would ensure that banks did not use the implementation of the ring fence as a smokescreen for avoiding or shifting their outstanding liabilities.

In recent times, considerable liabilities have fallen on some of the ring-fenced banks, for example, as a result of the mis-selling scandals. In such cases—whether it is to do with the mis-selling of interest rate hedging swap products or payment protection insurance—persons who have conducted business with those banks may be due compensation, which in some cases may be significant. Because outstanding liabilities may be large, it is important that the Commission had an opportunity to raise that point, and I would be grateful if the Minister would address it.

Greg Clark (Conservative, Tunbridge Wells)

The Commission and its representative on earth, or at least in the Committee, make a series of reasonable points. As we have discussed, the schedule relates to the powers of the higher courts to sanction a ring-fencing transfer scheme under section 111 of FSMA. To remind the Committee of the process, the company—the bank, in this case—initiates the procedure. The transfer scheme allows a bank to transfer a business, or part of a business, to another entity with the approval of the court. Any application to the court for the approval of a ring fence transfer scheme must first be approved by the regulator; in this case, that would be the PRA.

The amendment proposed would prevent the court from sanctioning a transfer scheme if it thinks that that scheme could lead to either the dissolution of a company—a bank, in this case—or the transfer of liabilities in a way that prejudices its creditors’ interests. The hon. Gentleman is absolutely right that that must not provide an opportunity for a bank to avail itself of the ring-fencing rules to evade the responsibilities that might follow from past misconduct. In recent weeks and months we have seen examples of historic misconduct that quite rightly entails compensation and redress for those who suffered as a result of that, and it would be a perverse consequence if a move to introduce more rigour into banking standards were to give an opportunity to banks to shirk those responsibilities.

The Government’s view is that the safeguards that we have put in place should address that. I will outline those which are in the Bill already. First, the PRA’s consent is needed, and the expectation is that the PRA would refuse to sanction any scheme that was about artificially evading a bank’s responsibilities rather than a genuine implementation of the ring-fencing rules. Secondly, anyone who is adversely affected—whether creditors or, for these purposes, the mis-sold—is entitled to participate in the court proceedings. The court may approve an application only if it considers that application appropriate. It is not a rubber-stamping exercise; the court’s scrutiny is to determine whether the proposal is appropriate, so the court could refuse the scheme if it were to conclude that it was artificially avoiding liabilities, as that would clearly not be appropriate.

The amendment as proposed, notwithstanding the obvious good sense of its intent, has a couple of flaws. First, it would prevent the court from sanctioning a ring-fencing scheme if it involved the dissolution of a company; it makes it clear that

“the court must not make an order sanctioning the scheme if it considers that it might lead to the dissolution of a company”.

It is not always the case that the dissolution of a company would be prejudicial to the interests of depositors or creditors; it may be appropriate as a tidying-up exercise in a complex, multifaceted group to set up a company to close down permanently certain subsidiaries, so an unintended consequence of the amendment is that it would be excessively restrictive in cases such as that.

Secondly, there is a lack of clarity about what “prejudice the interests” means. We would need to consider whether that meant mere inconvenience: it could be that some depositors might find it inconvenient to have to move from a branch a few doors away from their home or business to one a few streets away, but we would need to be clear that the prejudice in question is meant in a more substantial sense than that.

I say to the hon. Gentleman that we have no difficulty with the point that he and the Parliamentary Commission make about being sure that the mechanism is not used to evade the continuing responsibilities that banks have to their customers, past and present. There are a number of ways in which we can reflect on whether we can be even clearer that the safeguards are there. It could be that the PRA, for example, is invited to consider these matters explicitly when it makes its assessment of whether a scheme should be sanctioned. It could be that there are different variants around this. If the hon. Gentleman is prepared to withdraw the amendment, then later in the Bill proceedings we will consider how what is very much an agreed objective between the parties and the PCBS can be made absolutely clear and unambiguous.

Chris Leslie (Labour, Nottingham East)

The Minister has been helpful in responding thoughtfully to the points that the Commission made on this issue. He set out in an important way that he felt there are a number of safeguards to prevent the unfair shirking of these liabilities, and the PRA will act as some sort of guardian on these matters. He also said that the victims of mis-selling and the creditors will be able to participate in court proceedings. I know that is the case, but the Minister will forgive me if my heart sinks when I hear that that is a possible option. In reality, for a lot of consumers that is not a viable route for them to use. It is true that there are a number of safeguards in the current wording of the Bill, such as the appropriate choices that the courts might make. However, those safeguards are not as tight as they could be.

I very much welcome the Minister’s commitment to reflect on the points that the Commission made. He made a fair point about the drafting of the amendment when he said that we need to elaborate on what we mean by the prejudicing of certain interests. I hope the Minister will come back at another opportunity with a way of tweaking these provisions. I beg to ask leave to withdraw the amendment.

Clause 8 - Building societies: power to make provision about ring-fencing

Greg Clark (Conservative, Tunbridge Wells)

As we know, the principal reforms in the Bill are not directed at building societies. However, building societies should not be exempt from the restrictions that a ring fence would propose. Currently, the restrictions on building societies in the legislation that applies to them are analogous to those that apply to ring-fenced banks. There is a danger that if building societies fall within the scope of the Bill they will be obliged to comply with two bodies of legislation that broadly have the same intent. If we are to avoid having two sets of primary legislation we would have to repeal the Building Societies Act 1986, ring-fence building societies and remove the special nature and recognition that they currently have.

The answer to the conundrum posed in policy terms by the introduction of these banking reforms is, as we propose, to exempt building societies from the ring-fencing rules. To ensure a level playing field, clause 8 gives the Government the power to amend, via statutory instrument, the legislation that currently applies to building societies to bring them into line with the ring-fencing rules for banks. We will publish the consultation that will give effect to these provisions, including the draft statutory instrument, over the summer for a full public consultation. The approach that we have set out has been much reflected on and consulted on during all the stages of consultation on the Bill and the draft Bill. It has been warmly endorsed by the Building Societies Association. So it is a pragmatic solution to a particular problem.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

It is a pleasure to serve under your chairmanship again this morning, Mr Bone, and to be able to make a few comments about clause 8. As the Minister outlined, it deals with the treatment of building societies as far as ring-fencing regulations go. It is important that he put on the record the Government’s desire to solve what he described as the conundrum of having different sets of legislation to comply with and the need for a level playing field. That has been welcomed by the building society sector. As he explained and as the explanatory notes outline in some detail, building societies are excluded from the definition of ring-fenced bodies because they already operate under the significant restrictions of the Building Societies Act 1986.

Under current rules, 50% of a building society’s funding should be in the form of retail deposits and 75% of lending must be secured on residential property. That gives them their particular significance and there is concern that that may change. We are not entirely clear what the Government intend to do following the publication in 2012 of the Treasury consultation on the future of building societies. I will come back to a couple of questions around that. Clause 8 aligns the reform for building societies to that which will apply to ring-fenced banks under part 9B of FSMA. Building societies and ring-fenced retail banks will be treated in broadly the same way. That is the right and proper thing to do.

We know the importance of building societies and the wider mutual sector to the economy. Building societies in particular form a vital part of our UK financial services sector. Mutual lenders and deposit takers have total assets of more than £375 billion and, together with their subsidiaries, hold residential mortgages of £245 billion. Building societies are often the very organisations that have worked closely with local communities and with people to ensure that they get a start on the housing ladder. They hold more than £250 billion of retail deposits and that accounts for more than a fifth of all such deposits in the UK. Some 50,000 people work full and part time for building societies in approximately 2,000 branches, which shows their spread. Building societies have been able to continue in many instances with those high street branches. They have largely proved to be prudent and sustainable. Only one building society needed Government support during the financial crisis when in March 2009 the Treasury dealt with the issues surrounding the Dunfermline building society. The Nationwide went on to buy all Dunfermline’s branches, good loans and deposits.

I welcome what the Minister said about publishing a consultation and draft legislation over the course of the summer on this issue. How will that sit in the context of any wider action that may come from the Government following the commitment that was given in the coalition agreement:

“We will bring forward detailed proposals to foster diversity in financial services, promote mutuals and create a more competitive banking industry”?

While the Minister is doing something about tidying up the process in relation to building societies, we are still rather unclear about what the Government’s intentions are following the consultation that took place on the Building Societies Act 1986. He may be able to tell us more about that.

My other question may be also be covered by the consultation in the summer. What new functions relating to building societies are likely to be handed to the Financial Conduct Authority or the PRA? Those are some technical points that are covered in the clause. In general I have no difficulty with the clause and, as I said, it has been welcomed. But it would be useful to have some of those points on the record, so that we can be clearer about what the Government intend to bring forward and how that relates to the Bill.

Greg Clark (Conservative, Tunbridge Wells)

I am glad that we have the support of the hon. Lady on how we intend to proceed on this. She is right that we want to see a greater diversity of competition in the sector. The provision of financial services has become far too concentrated as a result of the crisis and we want to see an expansion of the market share of smaller players, particularly building societies and mutuals. I will address some of the ways that that is already being carried out.

First, the hon. Lady will know that the Financial Services Authority has been conducting a review on the barriers to entry for the authorisation of new banks. It has introduced a new system and committed to recognising the special circumstances and improving some of the aspects of financial resilience that come naturally to institutions with a longer pedigree. If the risk, particularly the systemic risk, is low from the start, that should be taken into account.

When we consider the new clauses, we will have the opportunity to discuss some further measures that the Government propose to table. We will shortly publish a consultation on the changes to payment systems. Those changes will allow access to the payments systems for those who are outside the magic circle of firms that control access to them. There will be an opportunity for those concerned to contribute to that consultation.

We are keen—I made this point at the beginning—to take the views not only of the Parliamentary Commission but of the House, both in Committee and at later stages of the Bill, on how we can further reinforce our determination to drive competition in the banking sector. That includes building societies.

The PRA and the FCA are required to make a specific assessment of the proposed rules on mutual societies. We recognise that although mutuals compete and operate in the same spaces as banks, they are from a different tradition. Their capital requirements and operations are different. The provision will ensure that the regulators will not unintentionally disadvantage mutual firms when creating rules. It will also build up an evidence base that can be used to ensure that mutuals are treated appropriately in the regulatory system. The regulatory principle of proportionality also applies in this regard. If regulators are taking action that impacts one firm more than another, it should be done only on the basis that it is proportionate to each of those firms.

As part of the consultation on this part of the Bill, we will be open to suggestions from the building society movement and depositors and lenders from building societies. We will consider, both through that consultation and anything that is suggested by the Parliamentary Commission or the House, whether any further legislative change is needed, including within the Bill, which is a vehicle for that. What we have introduced in the Bill meets the requirements set out by most people in the sector by ensuring that the sector is treated fairly and properly while recognising its distinct characteristics. As I have said, we are happy to consider further legislative steps if they are needed.

Clause 9 - Preferential debts: Great Britain

Chris Leslie (Labour, Nottingham East)

I beg to move amendment 7, in clause 9, page 15, line 25, at end insert—

Peter Bone (Conservative, Wellingborough)

With this it will be convenient to discuss the following:

Amendment 8, in clause 9, page 15, line 35, after ‘Financial Services Compensation Scheme’, insert ‘and deposits of charitable bodies’.

Amendment 9, in clause 9, page 15, line 36, at end insert—

Chris Leslie (Labour, Nottingham East)

Given international events, clause 9 has suddenly become significant. Amendments 7, 8 and 9 were tabled before we heard about the Cypriot crisis in any great detail, but they provide an opportunity to ask what would happen in the event of bank insolvency, especially to depositors. The amendments are probing and seek to tease out the Government’s thinking about the impact on charities that are depositors in banks that may become insolvent. We will discuss why banks have preferential creditors in the clause stand part debate.

Many charities in this country painstakingly raise funds from their supporters, benefactors and donors, but they do not keep those funds stashed away in a safe at the back of the office. They trust them to the banks for safekeeping. Imagine the thoughts going through the minds of trustees of charities of Cyprus, where, as I understand it, if they have deposits of over €100,000—they may not be classed as individual depositors at all and even that first €100,000 may not be safe—they may find that, with the swipe of the pen of the Eurogroup of Finance Ministers, all their hard efforts were for absolutely nothing. We must think through the consequences of what would happen in this far larger country with far larger charities. There would be many significant downstream consequences.

Amendment 7 is perhaps the best actively to show how one solution could be pursued. It is only one solution, but I shall be grateful if the Minister will give us some reflections on it. The clause amends the schedule to the Insolvency Act 1986 that sets out the ranking of various categories of creditors in the event of insolvency. The taxman obviously comes pretty high up in that list—that will not be a surprise to hon. Members—and there is a pecking order for the scramble of creditors trying to get the remaining resources and assets. Amendment 7 would give a measure of specific protection to the charities.

We need to protect charities’ deposits when constructing this new financial architecture. We should not allow such deposits, which may have been built up over decades, simply to be flushed away if a bank fails. According to the submission to the Parliamentary Commission on Banking Standards from the Charity Finance Group, the charity sector in this country holds some £18 billion in cash deposits. The amendments would include charities’ deposits under the deposit insurance scheme known as the Financial Services Compensation Scheme.

Amendment 7 represents the meat of the changes. Amendments 8 and 9 are consequential and relate to the Bankruptcy (Scotland) Act 1985. The amendments probe what might be the right solution. We picked up the position that was the case under the Financial Services Compensation Scheme up until 2007. At first, 100% of deposits were covered up to £2,000 and 90% of deposits up to £33,000. Those were the old rules. By extension, we are asking what would be the case if there were a 90% protection regime for charities’ deposits. On reflection, particularly in the light of Cyprus, we should have tabled a parallel amendment that would have protected 100% of charities’ deposits. That would also be a reasonable suggestion. I am not sure that even a 10% haircut for charities would be acceptable.

Stephen Doughty (Labour, Cardiff South and Penarth)

It is a pleasure to serve under your chairmanship for the first time, Mr Bone. My hon. Friend makes a strong point and I am interested to know the Minister’s views. As the Committee is aware, I was previously head of Oxfam Cymru and had a career in the charity sector. There will be great concern about the clause, particularly in the light of the Cyprus example. I hope we would never get to that situation in this country, but it is important to have adequate safeguards in place.

It is also important to be aware, as my hon. Friend might not be, that a number of British charities often hold substantial amounts of funds transferred from the UK Government before they transfer them to overseas projects, in the case of the international development sector. Funds of possibly hundreds of millions of pounds could be put at substantial risk.

Chris Leslie (Labour, Nottingham East)

I am grateful to my hon. Friend who has a lot of experience in this field. Any further observations would be useful. His point that charities often hold public funds in trust is key. As the Charity Finance Group said in its written submission to the Parliamentary Commission:

“Charities have a unique set of requirements when it comes to banking. Their funding structure, public benefit function and activities all mean that they bank differently from other classes of customer (for example, individuals and businesses), however the protections in place for charities (i.e. Financial Services Compensation Scheme coverage) does not recognise the distinctive nature of charity banking.

In the period following the crisis it became apparent that there was a clear gulf between charities’ exposure to risk and capacity to manage it, and their level of protection. This was also acknowledged by the Treasury Select Committee during their inquiry into the banking crisis.”

There is sometimes a cold attitude from the authorities when they say to institutions, particularly to businesses but also implicitly to charities, “If you are an institution you should simply know whether a bank is safe or not. You should do due diligence; you should not just trust that banks are naturally safe.” Some smaller charities could easily have sums above the FSCS level and may not be protected. It would help if the Minister could clarify that point. It is not reasonable for them to make a financial judgment about whether a bank is likely to go under and what individual insurance arrangements they should make for those circumstances.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

Does my hon. Friend share my concern, also expressed by the Charity Finance Group, the National Council for Voluntary Organisations and the Association of Chief Executives of Voluntary Organisations? In the context my hon. Friend describes, charities will find themselves, as outlined in the CFG’s submission on banking reform, having to follow

“more conservative banking practices and deposit in those banks deemed lower risk, which typically pay a much lower deposit rate”.

That will mean that the income available to charities will decrease over time.

Chris Leslie (Labour, Nottingham East)

We debated on another clause whether ring-fenced retail banks might find themselves in a low-return environment compared with investment banks. That leads to another facet about charities that might be tempted to invest their money outside the ring fence. We have a waiver for high net worth individuals. I am not sure what waiver protections exist for charities and their trustees, to ensure that, if they venture outside the ring fence, there is some process by which they have to prove that they have considered those risks. It would again be useful if the Government could reflect on those points.

The Parliamentary Commission on Banking Standards considered

“the Treasury’s case that all non-insured creditors, including charities and small businesses and temporary high deposits of households, would be treated alike in the event of failure”.

The Commission found that case “unconvincing”.

The depositor preference principle laid out in the Bill fails to recognise the unique position of charities. In fact, it increases risk by pushing them further down the creditor hierarchy, because the Bill would include recompense for the FSCS essentially in that process. There is the irony of potentially increased risk. Our proposed solution would grant charities preferred creditor status, so that charity deposits would rank alongside those of the FSCS in the event of bank failure.

I would not claim that the amendment is perfectly formed. There is room for improvement—certainly, the level of reclaim is open for debate. However, it would be better than a 0% ability to reclaim.

The PCBS recommended that

“the Government and Bank of England establish a joint group to prepare and publish a full report on the implications for resolution of depositor preference and of the scope and extent of depositor insurance.”

That would be good as far as it goes, but I am not sure that it goes quite far enough. The PCBS also said:

“This report should, in particular, consider the feasibility of establishing a voluntary scheme of insurance for deposits over £85,000 with arrangements for opt-out. This report should be published at least two weeks before the House of Commons report stage of the Bill.”

I am grateful to the PCBS for its recommendation. It certainly helps to inform the debate, particularly now that the international spotlight is being shone on such questions. British charities were hit by the collapse of the Icelandic banking system in 2008. Surely we have to learn from those events.

In the UK, there are at least 5,700 charities with cash assets of more than £85,000, so it is a big issue here. Today, Britain’s charities are under significant pressures elsewhere: declining Government grants, higher overhead costs and knock-on effects of donors facing higher living costs. The Prime Minister used to talk about the big society—admittedly slightly less so these days—but it would be important for the Government to rediscover some of those principles and take specific action in the Bill. We could do that on an all-party basis, which would be welcome to the charity sector, showing that we are thinking about the sector’s potential situation in the event of a banking insolvency. It would be an important step to take, and I would be grateful if the Committee could support the spirit in which we have tabled the amendments.

Jacob Rees-Mogg (Conservative, North East Somerset)

It is a pleasure, as always, to serve under your chairmanship, Mr Bone.

We should treat the amendments with caution, because not all charities are small charities that creep over the £85,000 limit. In my business career, I have managed the funds of multi-billion-pound charities. They are sophisticated investors who do not need or want such protection. If they are too heavily protected, they may find that they cannot run their investment management side as effectively as they would want to the long-term benefit of their charity. If they are to be given an almost complete protection on deposits, there will in return probably be restrictions on the deposits that they can make. We should be careful about lumping all charities together. If such an amendment were to be made, we might want a higher rather than an unlimited threshold.

The second reason to be cautious of the amendments—I may simply have been in the City too long—is that, in the few minutes that we have been discussing the amendment, I have been trying to think of a financial instrument that a charity could issue to a non-charitable body that it could deposit with a bank, to be covered by the ring fence, which it would then place with the most dubious ring-fenced bank, paying the highest rate of interest, to take a share of the revenue for the charity and make a guaranteed profit for the person who buys the financial instrument. I see that my hon. Friend the Member for Chelsea and Fulham is looking interested in devising such a product. The two of us, from our professional careers, find such things extremely interesting. There are always possibilities of that kind; it is the law of unintended consequences.

I am not unsympathetic to the amendments, but if they are to be adopted, large charities need to be able to carry on with the financial activities that lead to profit for them and allow more good causes to be undertaken. We also need to bear in mind that whenever the Government provide a protection, some clever person—or some not-so-clever person—will think up a scheme to use it in a way that was never intended.

Stephen Doughty (Labour, Cardiff South and Penarth)

The hon. Member for North East Somerset has made some important points, which are worthy of significant consideration. This issue clearly has to be looked at very carefully. My hon. Friend the Member for Nottingham East has made clear that the amendment is not necessarily perfect and would need to be looked at in detail, but he made some important points about exposure, the ability to manage and that differentiation in the charity sector as a whole. He mentioned the example of Iceland and Icesave, which is an important one; I recall being in Oxfam at that time and having a number of conversations with others in the sector who were deeply worried. The situation came upon many people as a great surprise, and people were running around and saying, “Do we have investments there? Are there things we should be worried about that we were not even aware of?”

Nevertheless, following on from the points made by the hon. Member for North East Somerset, it is worth remembering that a number of larger charities have systems in place to guard against risks. Those that operate internationally, in particular, have fairly extensive exchange rate hedging agreements. Charities take their fiduciary responsibilities seriously, particularly with regard to donor moneys. However, there is a differentiation in the sector, and in my experience of dealing with sub-grantees, with which the larger charities often operate in partnerships, they simply do not have the capacity, knowledge or awareness to make sure that they are hedging against all the risks. That creates challenges, particularly when sub-grantees also then take on significant contractual obligations to the ultimate donor, whether that be Government or a body such as the Big Lottery Fund, Comic Relief or other public funds that grant to larger charities, which then grant on to smaller organisations to deliver on the charitable objectives. That is before we think of moneys coming in from the public, which can often be significant, particularly in the case of high net worth individuals making bequests or other generous donations.

I would be interested to hear from the Minister how he and the Government will respond to the challenges, given that differentiated sector and the different levels of capacity and experience that exist to deal with this issue. Will they ensure that risks are looked at in quite careful detail at all levels of the system, so that we do not have a repeat of the Icesave example and others, which caused significant challenges to a number of charities both medium-sized and small, as well as to local authorities and others that I mentioned in previous contributions?

Some important points have been made. The amendments might not be perfect, but they hit on an important point, and I hope that the Committee gives them due consideration.

Greg Clark (Conservative, Tunbridge Wells)

It has been a useful debate on an important matter, which is the more topical given the events going on in Cyprus as we speak. No one could be anything other than sympathetic to the concerns the whole Committee has about making sure that funds that have been subscribed by ordinary working people up and down the country are not lost somehow in the event of bank failure. The issue is germane not just to this discussion but to the one I hope we will have later today about bail-in provisions; it is not depositors—whether charities or individuals—who would be in line to bail out failing banks in this way.

Let me set out the context for why the Government have proposed the particular approach to depositor preference that we have, and then deal with some of the points that have been made. The amendment would make the first 90% of charities’ deposits preferred debts in bank insolvency creditor hierarchies. The purpose of the clause is, in effect, to align the deposits covered by the Financial Services Compensations Scheme with preferential debts in the hierarchy. It is designed to introduce consistency between the compensation scheme and the treatment in the hierarchy.

The context is important. I remind the Committee that this is, in essence, a zero-sum game. In the event of a bank insolvency, there is no extra money that could be found. Depositor preference is about distribution of risk. The more one group is protected, the less protection there is for another. Whatever the Committee and the House ultimately decide, as we have seen in Cyprus, it is important to be clear in advance as to what would happen, so that people can make decisions on that basis rather than there being uncertainty as to what the consequences would be for depositors of all sorts. The fact that measures to that end are in the Bill and are being debated is important.

The recommendation of the independent Vickers Commission was that FSCS-covered deposits—that is to say, insured deposits—should be preferred, but not others. As the hon. Gentleman mentioned, the Parliamentary Commission looked at this again and was not able to come to any definitive conclusion, reflecting the difficulty of the choices it made. It recommends having a joint study group. We note that recommendation and will reflect on it. In some ways it points to the difficulty of the issue when such a distinguished and experienced body of people as the Parliamentary Commission did not feel able, even through one of the sub-committees set up to investigate different matters, to come to a firm response on this.

Why would the approach recommended in the amendment—to insert charities into the hierarchy alongside the preferred depositors in the Financial Services Compensation Scheme—have drawbacks? First, one of the principal purposes of the Bill, which comes straight out of Sir John Vickers’s recommendations, is to protect the taxpayer—the ordinary working people of this country—from the costs of bank failure. Insured deposits are guaranteed by the FSCS. It pays out immediately to insured depositors and then takes on their claims as creditors of a failed bank.

What happens if there is a shortfall in the recoveries? The FSCS levies other, well run banks. It is important to reflect that doing that can be a source of potential contagion. It can impose risk and costs on other banks’ creditors and depositors. The liabilities have to go somewhere. That may be on perfectly reasonable grounds, as set out in terms of the establishment of the FSCS, but we should remind ourselves that it means other banks with other customers and other depositors being exposed to that risk. In circumstances in which the FSCS cannot pay immediately, or perhaps ultimately, the taxpayer bears the contingent liability. The Bill is designed to protect the taxpayer from the consequences of bank failure that were evident in the past, so there are strong reasons to align precisely the terms of the FSCS and the depositor protection preference category.

Having done that, should we include charities? Moreover, should they be included in the FSCS? If we want to maintain consistency, perhaps a clearer and more consistent way of doing it would be to address whether they should be part of the depositor hierarchy. That gives rise to a debate that we have started to have in the Committee about whether depositor preference should be extended to good causes. Good causes certainly include charities but are not limited to them. For example, schools, hospitals, local authorities, medium-sized businesses that are important for the community and private sector pensions into which people have paid are all sources of funds that could constitute good causes in no lesser way than charities. The trouble is that if everyone is prioritised, no one is prioritised.

We need to make some decisions here. It could give rise to some difficult consequences if we drew the line at charities, no more and no less. If charities were to be included, the deposits held by a private and independent prep school could be included, whereas the reserves held by a state primary school would be excluded. I think most people would consider that to be anomalous. As my hon. Friend the Member for North East Somerset pointed out, the vast majority of charities are covered under the FSCS at the moment. About 1.8% of charities are not eligible for any FSCS protection on account of their size. In total, some 3.5% would have deposits above the £85,000 limit. It is important that our constituents, who—you never know—might be reading this debate, are reassured that the vast majority of charities’ deposits are already covered under the Financial Services Compensation Scheme under the Bill, and that it is recommended that they will enjoy the protection of that scheme.

Chris Leslie (Labour, Nottingham East)

I would be grateful if the Minister clarified something. Forgive me for my lack of familiarity with the particular terms of the Financial Services Compensation Scheme, but I think that he is saying that charities, and presumably therefore all depositors, including businesses, schools or others, are covered up to that £85,000 level, or is it only individuals who are covered up to that limit?

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman raises an apposite point. The current coverage of the Financial Services Compensation Scheme is for individuals whose deposits are protected up to £85,000, and for small organisations—he will want to know the definition, which has come up previously in Committee—that meet at least two of the following conditions: they should have a turnover of less £6.5 million per annum; they should have fewer than 50 employees; and their balance sheet should be less than £3.26 million. Those are the current criteria. The scheme is limited to small organisations and individuals.

Having said that, the hon. Gentleman will be aware that the terms of the Financial Services Compensation Scheme have changed from time to time. He noted that before 1 October 2007, the total limit was £31,700, with 100% protection of the first £2,000 and 90% of the next £33,000. That increased between October 2007 and October 2008 to 100% of the first £35,000. Between October 2008 and 2010, it increased to 100% of the first £50,000, before being aligned with the European standard of 100% of the first €100,000—or £85,000—of deposits. Measures are being debated in Europe to extend some of the categories of coverage of the European standard, which may address some concerns and about which I will say more in a moment.

It is important to send a message to charities in this country that the vast majority of them are covered by the existing arrangements. Only 1.8% of charities fall outside the size threshold for organisations and only 3.5% fall outside the criteria for deposits over £85,000. We are therefore dealing with a small minority of charities. As my hon. Friend the Member for North East Somerset said, some charities are organisations of sophisticated financial expertise, which is quite right given the extent of the deposits that they control and of their financial resources. For all the reasons that the hon. Members for Nottingham East and for Kilmarnock and Loudoun gave about charities getting the best returns for their investments, if they are sophisticated, well run and have the financial acumen and advice to make with clear sight investments that may entail a degree of judicious risk, they should not be prevented from doing that. The ring-fencing rules provide that charities with sophisticated individuals can invest outside ring-fenced bodies. Indeed, charities with a gross income of more than £6.5 million will be able to bank outside the ring fence, which reflects those matters.

One would not want inadvertently to constrain charities who make good returns for their beneficiaries through having built up, over time, an impressive track record of sophisticated investment management. That is not the intention here.

Chris Leslie (Labour, Nottingham East)

The Minister has been generous in giving way. To be clear, would it be possible for charities with less than a £6.5 million turnover to bank outside the ring fence, or would they be prevented from doing so? I am worried that there may need to be a waiver provision for charity trustees, if they are to venture into those slightly riskier banking environments, to make sure that they are fully aware of what they are doing with their members’ funds.

Greg Clark (Conservative, Tunbridge Wells)

Just to clarify, if charities do not have a turnover above £6.5 million, they are required to stay within the ring fence. As in the discussions that we had on sophisticated high net worth individuals, if they are below that amount, they are assumed to be—in a non-pejorative way—unsophisticated and are required to keep their deposits within the ring fence. That is the state of affairs.

It is sensible to align the protections of the FSCS with the depositor preference hierarchy to have a rational approach to the risk to the taxpayer. It is not possible to draw a bright line between charities and other good causes, however appealing that may be. I suspect that that lies behind the Parliamentary Commission’s reluctance to endorse this simple principle, but that would give rise to instant anomalies that would be troubling to members of other organisations. As I said earlier, the FSCS coverage has been extended to include not just individuals, but small organisations.

Proposals to amend EU law through the deposit guarantee scheme directive—this is currently being debated and the directive is likely to be amended well before 2019 when the depositor preference hierarchy provisions would come into effect—are in motion already. Actually, as currently proposed, the European compensation scheme standard, to which the FSCS would comply, would extend to other organisations, including charities of all sizes, which is the approach recommended here.

The Government are certainly sympathetic to the concerns that lie behind the amendments. I am conscious that, as the hon. Gentleman said, the amendments were tabled to give rise to a debate and to probe the Government’s position. During the passage of the Bill, the Government will certainly listen. We want to keep things simple, as the ICB and Parliamentary Commission have recommended, because a proliferation and a cat’s cradle of exemptions and inclusions can serve only to confuse.

The vast majority of charities are already protected. The clarity and simplicity of our approach in aligning the interests of the FSCS and the depositor hierarchy makes sense, but there is the question of the scope of financial services compensation schemes in this country and around the world. My inclination is to think that, for the Bill, the important requirement is to align the compensation scheme with the creditor hierarchy and that any extension of protection to other organisations might best be done through the debate, between now and 2019 when it takes effect, about what the depositor insurance schemes in this country and across Europe cover. I hope that the opportunity to set out the Government’s views has been useful. I am certain that we will have occasion to debate this matter again during the Bill’s passage.

Chris Leslie (Labour, Nottingham East)

It is helpful to hear the Minister’s careful thoughts on this issue. I do not doubt that he has been looking at this question in some detail, but I think that the Parliamentary Commission on Banking Standards had a point when it said that the notion that somehow charities, small businesses or individuals with temporary high deposits would be treated just like everybody else in the event of an insolvency is unconvincing. I think that that is probably right. Let us face it, if that happened in this country, there would be a massive amount of political pressure on elected representatives and Ministers. Of course, there would be some reaction from the body politic if charities were crying out for extra assistance in such circumstances.

We have to be realistic and confront that imaginary scenario—perhaps less imaginary given the Cypriot circumstances—and for the sake of preparedness and contingency spend a bit of time now thinking through what would happen, rather than bodging together some taxpayer bail-out for particular organisations at the last minute. The Minister implied that his preference would be to start with a depositor protection scheme, as opposed to a depositor preference scheme, as a way to look at expanding the insurance arrangements. That is a perfectly viable scheme.

However, in his opening comments, the Minister said that the Parliamentary Commission obviously found this issue very tough, that they are very eminent and that the best they could do was call for a review group to be set up jointly with the Bank of England. He said that he will note and reflect on that recommendation. With the greatest respect, I do not think that we should have a review into whether we should have a review. We should just have the review, be done with it and get on with it so that fairly soon we can put in place a process that reaches a conclusion so that we can plug this gap—this lacuna—that clearly exists in the rules.

Clearly, if we accepted that definition of good causes, it does spill out beyond charities. That is a perfectly viable argument. As I said, the amendment is probing. On reflection, the 90% is a moot point as it would entail a 10% haircut, which is an even greater haircut than the hon. Member for Chelsea and Fulham had yesterday at the barber’s. He must have asked for a Cyprus, but I digress. It is important that we find a way to have the maximum possible protection for charitable bodies, because even though there may be only a small number that spill beyond the FSCS protections, they are nevertheless good causes and people would be shocked if they were fleeced by insolvency arrangements.

It is important that the Minister makes a decision about what the process should now be. It is perfectly reasonable for him to try to initiate the review set out by the Parliamentary Commission and it is right that the Bank of England and others should think about the potential for extensions to the FSCS if that is the Government’s preferred route, but it would be nice if we could find some way of resolving this in 2013. Heaven knows what is around the corner.

Greg Clark (Conservative, Tunbridge Wells)

Obviously, the context of Cyprus injects a sense of urgency into our proceedings, but the amendment that we are debating would take effect from 2019. If we thought that there was an urgent need to consider the arrangements for charities and other bodies, it could be that the Bill, taking effect in 2019, may not be the most opportune vehicle anyway.

Chris Leslie (Labour, Nottingham East)

That is true, except for the possibility of a Government new clause being introduced that would change the Bill on Royal Assent, maybe in 2013—who knows?—but more likely in 2014. There are ways and means of using the Bill to deal with things more quickly, certainly in relation to the FSCS. We need to know that the Minister is in a dialogue with the FSCS and that he is talking to the Bank of England so that this will not simply be an interesting little vignette debate that took place in the spring of 2013. We need more than that.

However, it is important that we have had this discussion. I shall not labour the point. I am happy to withdraw the amendment, notwithstanding the fact that we will want to come back to the matter. It is likely that we will want to revisit it on Report, but I beg to ask leave to withdraw the amendment.

Greg Clark (Conservative, Tunbridge Wells)

We have had a useful discussion. I can certainly confirm to the hon. Member for Nottingham East that we will continue to think actively in this area. The points in the debate on the amendments were well made. It is not a debate for only the spring of this year. I suspect that their lordships will also give close attention to the subject.

The Independent Commission recommended the introduction of depositor preference, ensuring that the FSCS treat deposits as preferential. It is important that people have confidence in the deposits in banks, although the insurance scheme is not free of consequences for the taxpayer. The FSCS is to borrow £20 billion from the Government to fund its obligations during the crisis, and the taxpayer will continue to carry the contingent liability until that is repaid.

Depositor preference means that the compensation scheme can recover more of the sum that it pays out from the bank’s assets than would otherwise be the case if it were not preferred. It helps by reducing the likely charge through the levy on other banks, reducing the risk of contagion. Also, it sharpens the incentives on investors, rather than taxpayers, to monitor and manage the bank’s risk, given that they will bear more risk than other depositors.

I have already mentioned that the European deposit guarantee scheme directive will, as we anticipate, extend FSCS coverage further to businesses and many other organisations. We will have a debate about that. We will reflect on this debate and see what further suggestions we can make during the passage of the Bill.

Mark Durkan (Social Democratic and Labour Party, Foyle)

It is a pleasure to serve under your chairmanship this morning, Mr Bone. I want to address the obvious question of territorial extent. As I represent a constituency in Northern Ireland, it is striking that the provisions on preferential debts apply to Great Britain with distinct references to England, Wales and Scotland. That is obviously because of our separate bankruptcy laws. Given that the Financial Services Compensation Scheme and the other provisions are understood by everybody to be UK-wide, the question arises as to particular wrinkles potentially being built into the future arrangements by virtue of differential treatment for Northern Ireland.

I recognise that the Presbyterian Mutual Society was not a bank—it was an industrial and provident society—but when the crisis hit that organisation, widespread, misplaced assumptions and understandings emerged, including at levels of government, about what the regulatory set-up was in Northern Ireland. What was regulated did not extend in the manner that people understood. Of course, the Financial Services Authority should have been regulating much of what the PMS was doing, because it went beyond what an industrial and provident society should have been doing.

The situation revealed that a whole twilight zone had been created in which odd and strange things happened, in which the regulatory system, the Government and the legislative systems both here and in the Assembly were giving confusing answers and explanations to people who were in a state of distress and confusion. A lot of the moneys held by the Presbyterian Mutual Society were—as the previous discussion touched on—held by charitable trusts, and the question arose of who should have preference in the resolution of that situation. Given our discussion on previous amendments, it is appropriate to ask how far we are factoring in the future situation in Northern Ireland.

As a banking market, Northern Ireland is distinct. The high street banks in Northern Ireland are branded very differently from those here. It is also a banking market that will undergo change. First Trust is up for sale, there will always be rumours about Ulster bank being spun out of RBS, and we have experienced the collapse of Anglo Irish bank. That bank was wrapped up into the Irish Bank Resolution Corporation along with Irish Nationwide, which also had some business in the north, and recently the IBRC has, in effect, moved for insolvency. There is experience of banking players in Northern Ireland finding themselves in an insolvency situation, which is why I ask the Minister to shed some light on what he understands will be the situation in Northern Ireland. Has he been given any indication by the Department of Enterprise, Trade and Investment Minister in Northern Ireland of further legislative changes in Northern Ireland that might bring the position in Northern Ireland into some alignment with the position in England, Wales and Scotland as set out in the Bill?

If the Minister is not in a position to answer all those questions fully now, I am prepared to wait for fuller answers until the debate on clause 19, which deals with the territorial extent and which refers specifically to this clause and the exception it contains. But given our experiences in Northern Ireland of thinking that everything would be all right because the spirit of the thing was good, we need to get this right. It seems strange that we have a compensation scheme for the UK that may operate differently in Northern Ireland. We had some experience of the difficulties that such differences may cause in the background to the Presbyterian Mutual Society. The investigation into the Presbyterian Mutual Society showed that in some parts of Northern Ireland, bank managers were saying to PMS customers, “You are not protected there. You should move your moneys into our bank, where you will be protected by the bank guarantee,” which started to create a bit of a run on the PMS.

Credit unions in Northern Ireland had similar problems. Although they managed to avoid a run, they were caught in a situation where credit unions in the south were covered by the very generous guarantee given by the Irish Government but credit unions in Northern Ireland were not covered by anything other than their own bonded guarantee within the Irish League of Credit Unions. Credit unions worked hard to make sure that that allowed them to survive a potential run, but in the sort of situations that we are looking at—people have mentioned Cyprus—if there is any gap in protection, and if people with certain accounts in Northern Ireland feel that they have less protection, even under the Financial Services Compensation Scheme, by virtue of the fact that they are banking in Northern Ireland, that will create risks. People will feel that they are at some hazard so they might engage in hasty or rash action, which might have its own implications.

Chris Leslie (Labour, Nottingham East)

We had a useful debate earlier about how charities would be affected, and I would like to echo the comments of my hon. Friend the Member for Foyle, who raised some crucial points about the territorial issues that arise from the way in which the clause is structured. It would be useful for the Minister to answer those points.

The Parliamentary Commission’s main concern was about the areas that stray beyond the protection of the Financial Services Compensation Scheme, in which, in the event of insolvency, the uninsured depositors—whoever they are and whatever form they take—will scramble to recover some of their assets. The Cyprus situation brings that concern to the fore. I am not thinking just about the situation of charities, which we have debated, but of business. Most people think of small and medium-sized enterprises, but even mid-cap or larger companies can be significantly affected if a bank becomes insolvent, and obviously there are risks involved in that.

The Minister made a fair point when he said that if everybody is preferred, nobody is preferred. Similarly, it is worth stepping back here. We will come on to this issue when we talk about the bail-in arrangements because these issues bleed across. It is useful to imagine a scenario. We are adding higher preferential treatment to the FSCS arrangements. Clearly in this scenario there will be a greater knock-on consequence for uninsured depositors, who will be left with potentially greater risks as a result of the clause. I am not arguing against the clause; I think it is reasonable. Nevertheless, it is worth, in the balance of risk, trying to work out whether we are unwittingly creating an extra level of risk for uninsured depositors, and if so, what it is. In designing future bail-in arrangements, we will need to bear in mind in a more thorough way the downstream consequences for depositors who are not covered by the FSCS arrangements. Certainly, they will need to be informed by the EU resolution and recovery directive, which we are talking about, and how it develops.

We talked about charities earlier. It would be wrong of me not to specifically ask about other businesses and individuals who have temporary high balances. One can imagine a scenario in which an hon. Member is moving house and has vested their total housing assets with a solicitor over the weekend, the solicitor’s funds are in escrow in a bank, and suddenly the bank goes bust. What happens if somebody has temporary high balances? It is not inconceivable that even depositors with modest means could exceed the FSCS threshold in such a scenario. Similarly, it is not inconceivable that individuals’ life savings or lump sum payments could exceed the threshold. It is not necessarily the Russian oligarchs that we have been hearing about who allegedly have money in Cyprus; it might just be individuals with life savings, who have received a particular amount in a particular set of circumstances.

It is important to hear what the Government’s attitude is towards giving a level of protection to depositors with temporary high balances, and to individuals in those circumstances. Those are my questions. The Minister has already indicated that he believes that the best route to follow is to think about enhancements to the depositor protection arrangements. Nevertheless, he will understand that there will always be some uninsured depositors, and there will be consequences of that. I just want to get the sense that the Minister is thinking through the design of the clause with some of those questions in mind.

Greg Clark (Conservative, Tunbridge Wells)

Let me address the important and serious points made by the hon. Member for Foyle on behalf of his constituents. He will know that insolvency is a devolved matter in Northern Ireland, hence the different treatment of the arrangements here. However, the devolved Administration have said that they want to make the equivalent changes to the law in Northern Ireland in an insolvency Bill in the Northern Ireland Assembly. That is how they propose to ensure a degree of consistency in the arrangements. Should that not materialise, the Government have agreed with the Administration that they will table an amendment to the Bill at a later stage to give effect to this policy across the whole of the United Kingdom. Their preference is to maintain the principle of insolvency being a devolved matter and to have an appropriate Bill, but should that not be possible and should it prove more convenient later on, we can address it here. Either way, the intention is clear that the arrangements should be consistent across all parts of the United Kingdom.

Some historical problems that the hon. Gentleman has identified, such as with credit unions, are now, as I think he understands, a thing of the past, because the arrangement has been brought into line and credit unions are now under FSCS protection, which I hope provides comfort to current depositors, if not to those who lost out in the past and in terms of the disadvantage that credit unions suffered at the time. As I said, we might have a debate about that later in the Bill proceedings, depending on the progress in Northern Ireland.

The points raised by the hon. Member for Nottingham East come back to the question of preference applying to some people and, therefore, not to others. Inevitably, when it comes to the hierarchy of depositor preference, it is like squeezing a balloon; if more people are included, that has consequences for those who are excluded. The debate—which, to a certain extent, continues—in Cyprus over the past fortnight has been about to what extent it is reasonable to share the burden of that kind of forced bail-in between protected and unprotected depositors. As we have seen, the proposal last weekend was to have a higher contribution, it seems, from the uninsured depositors.

On the face of it, if we think only in terms of the depositor protection hierarchy, the consequence of including other categories is that we would increase the risk to others. However, that is a notional and theoretical risk, because as the clauses that we will debate on a bail-in show, it is absolutely our intention to ensure that other subscribers bear the responsibility for bailing in banks, should they fail in future, rather than depositors. The events in Cyprus make such discussions even more important.

I turn to the particular circumstances of people who ordinarily might be protected by the Financial Services Compensation Scheme, but might find themselves briefly outside it—for example, if there is a temporary holding of assets because of the sale of a house. In terms of the scheme’s simplicity, one can imagine circumstances in which including such exemptions could give rise to all sorts of litigation—where people were demonstrating that their holdings were fleeting and temporary—however clear the intention is to cover perfectly reasonable cases, such as constituents that are moving house over the course of a weekend.

However, as I said in our debate on the amendments, changes are being contemplated to the European directive on deposit guarantee schemes. We were pressing, at the European level, for precisely those sorts of contingencies to be included, and we were trying to find ways in which they could be specified that do not give rise to the unintended consequence that more or less any depositor could claim that they are covered by the compensation scheme, which would defeat the point of having the different categories with the protection that is there. That process is ongoing. The clause, as I mentioned, would take effect from 2019. Were we minded to go further, it is highly likely that the European arrangements would kick in before the clauses in the Bill, but no doubt, when we come to talk about that issue during future stages of the Bill, we will reflect more on where the European discussions have got to.

Mark Durkan (Social Democratic and Labour Party, Foyle)

I thank the Minister for addressing some of my questions. However, I am at a loss to fully understand his answer, in that the intention is obviously to respect the devolved nature of insolvency legislation in Northern Ireland, but any change to legislation, in respect of insolvency law, in Northern Ireland will not, of itself, be able to make provision about the Financial Services Compensation Scheme. No aspect of that is devolved, so the Assembly cannot legislate on the Financial Services Compensation Scheme, even though it is meant to operate as a UK-wide scheme.

Is there not a case for making some sort of “watch this space” provision in the legislation to permit that at a given future point, by order of the Northern Ireland Executive or a Minister there and of the Treasury, provisions can be made to extend clause 9—it exclusively covers Great Britain—to Northern Ireland as well? I am not sure that the Northern Ireland Assembly can legislate on the Financial Services Compensation Scheme. The Bill needs to make that provision in some way, or at least provide the housing for a future change.

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman makes an interesting point, but clause 9 is not about the operation of the FSCS; it is about insolvency law and who is protected in the event of insolvency. The hon. Member for Foyle is right that Northern Ireland legislation could not alter the FSCS, but the clause is about where the FSCS, with all the legislation that underpins it, appears in the creditor hierarchy in the event of insolvency. Insolvency law is a devolved matter and the discussions that have taken place with the Administration have established that deference should be paid to its being a devolved matter, although there is a clear expectation that either a law will be passed in Northern Ireland or an amendment will be made.

The hon. Gentleman said we should have something that says, “Watch this space,” but as far as having a placeholder, he personifies the injunction to watch this space. He is a Member of this House and can do that as the Bill goes to Report and Third Reading. He has friends in the House of Lords and they will be able to watch this space there and ensure that the agreement that has been reached with the Administration is reflected. The Government have no objection to facilitating the active intention on both sides, and I see no problems in discharging that.

Peter Bone (Conservative, Wellingborough)

It might be helpful to remind the Committee that, for reasons I am not entirely sure of, we are not allowed hot drinks in this room.

Clause 10 - Discharge of functions by the scheme manager

Greg Clark (Conservative, Tunbridge Wells)

Following the point made by the hon. Member for Foyle, this clause relates to the administration of the Financial Services Compensation Scheme and is therefore a legitimate subject for the Committee and Parliament. The FSCS exists, as we all know, to provide compensation in the event of a bank’s failure and is an industry-wide collective insurance scheme. Because it can borrow from the Government to fund compensation costs that the industry cannot absorb immediately without damaging financial stability, the scheme is an issue for the Bill Committee.

In 2008, the Treasury had to lend £20.4 billion to the FSCS to fund its provisions for the depositors of Bradford & Bingley, the London Scottish Bank and, later, the Icelandic banks. The failure of even a moderately sized deposit taker can entail a call on public funds, as we saw with the Dunfermline Building Society, to which the hon. Member for Kilmarnock and Loudoun referred. It was not even in the top 20 listed deposit takers in the United Kingdom, but it had deposits of £3 billion when it failed in 2009.

It is appropriate for the FSCS to have regard to the need for efficiency and effectiveness in how it discharges the functions because of that risk to public funds. That is not simply a concern for the industry; the public purse is exposed and the public interest is therefore engaged, so there is a need for the FSCS’s operating principles and management explicitly to minimise public expenditure, which is what the clause will do.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

We have moved on to a series of relatively short clauses that make technical changes to the Financial Services Compensation Scheme. I want to ask the Minister a couple of questions about clause 10 in the hope that he will give us further information. The FSCS, which he described as an “industry-wide collective insurance scheme”, provides compensation to consumers if a provider of financial services fails. It is funded by a levy on the financial services industry.

Crucially, as the explanatory notes clearly outline, the Financial Services Compensation Scheme can borrow from certain accounts administered by the Treasury to pay out quickly—something important that we support—providing that the loan is judged to be in the public interest. We again return to points that we have repeatedly made in relation to the wording of the legislation and the intent of the Government to ensure that such judgments are coherent and sensible and that we and everyone else understand how they are arrived at.

The clause will add a new section to the Financial Services and Markets Act 2000 to require the Financial Services Compensation Scheme manager—in other words, the chief executive—to have regard to efficiency and effectiveness, as the Minister said. It would again be helpful to tease out some of the issues involving both the public interests, and efficiency and effectiveness. Crucially, proposed new subsection (1)(b) mentions

“the need to minimise public expenditure attributable to loans made or other financial assistance given to the scheme manager for the purposes of the scheme.”

The new section is brief, but it will give quite a lot of responsibility to the scheme manager, so it would be helpful if the Minister advised us whether further instructions will be issued to the scheme manager, what sort of guidance will be in place and what expectations there will be.

The new section makes it clear that the scheme manager will have to take into account efficiency and effectiveness as well as the public interest test, but will the Minister say more about the factors that are taken into account by the Treasury in assessing a request for a loan from the Financial Services Compensation Scheme to get payments out quickly, so that we have an idea of that two-way process? In that context, will the Minister give us further detail about the procedure for resolving differences of opinion or even disputes between the scheme manager and the Treasury, if they interpret the public interest test and the issue of efficiency and effectiveness slightly differently?

As I have said, I do not have a problem with the intention behind the clause. It is of course important that when any financial services provider fails and money needs to go to those affected that that ought to be done as quickly and sensibly as possible. Given that the legislation refers specifically to the scheme and the scheme manager, it is important to probe the Minister’s intentions further and to ask how he will put in place safeguards to deal with any questions that may arise.

Greg Clark (Conservative, Tunbridge Wells)

The clause is fairly minimalist, as the hon. Lady implies, but relates to the fact that the exposure of public funds by the FSCS’s actions requires some reflection in primary legislation, which has not been the case to date. Nothing in the clause provides the power for the Treasury to intervene in the day-to-day activities of the FSCS; it is for the accounting officer to do so. We will come on to the appointment of the accounting officer when we debate clause 12. Committee members who have served on the Public Accounts Committee will know that an accounting officer who, as we shall discuss, is the chief executive, is held to account for their implementation of the requirements on them, which is appropriate. We should regard clause 10 as part of a scheme that includes clause 12. In effect, we will have an accounting officer for the first time in the FSCS responsible to Parliament, the National Audit Office and the Public Accounts Committee. To provide a basis for scrutiny, the accounting officer requires typical objectives, as do public bodies, to carry out their activities with “efficiency and effectiveness”. That is what is behind the choice of words.

It is not our intention to use the clause in any way to manage the FSCS; it is principally a scheme of mutual insurance among financial institutions and it is right that they should order it in that way. Given the ultimate exposure of public funds and the public interest in that exposure being minimised, the measures provide a hook for Parliament, through its Committees and bodies such as the NAO, which works on behalf of Parliament, to obtain the scrutiny that it would not otherwise have.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

I am listening closely to the Minister and looking ahead to what we will discuss under clause 12. To ensure that I have understood his argument fully and that it is on the record, will the Minister confirm that he is essentially suggesting that clause 10 must be seen in the context of clause 12, but there would be no circumstances in which the Treasury would intervene at any stage to direct, give guidance or information, or make requests to the scheme manager, and that the responsibility would be with the scheme manager to comply with the efficiency, effectiveness and public interest tests? Is my interpretation correct?

Greg Clark (Conservative, Tunbridge Wells)

Yes, the hon. Lady is right. No provision in the clause gives the Treasury, or indeed any other part of Government, the ability operationally to interfere in the running of the scheme, but it is important that the scheme is accountable to Parliament for the use of public funds when it uses them, and for the exposure of risk that might be entailed to public funds.

Clause 11 - Power to require information from scheme manager

Greg Clark (Conservative, Tunbridge Wells)

Clause 11 is one of a clutch of clauses that update the provisions surrounding the FSCS. It arises from the reclassification by the Office for National Statistics of the FSCS as “a central government body”, and as such the FSCS must be consolidated within Treasury group accounts. The FSCS current governance framework, given that it applies to a central body, does not give the Treasury sufficient direct control or scrutiny of the activities of the FSCS, including access to its accounts and the management information necessary to certify for audit purposes, for example, that its activities are up to the standard required under “Managing Public Money” or provide the financial information necessary to be consolidated in the Treasury’s accounts, which are then reported to Parliament.

The clause will provide the Treasury with the power to require specified information from the scheme manager of the FSCS. That will include forecasts for the parliamentary estimates and financial accounts to consolidate the FSCS account into the Treasury group account. The Treasury will not have the power to require the scheme manager to provide other information, and the day-to-day independence of the FSCS will be protected, as we noted in the previous debate.

The clause will ensure that the Treasury has access to the information necessary for the Treasury’s principal accounting officer to be able to assure himself or herself of the highest standards of regularity and propriety for the FSCS and to obtain the financial information that it is necessary to report to Parliament as a result of the reclassification.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

We have here a short clause; the Minister coined the term “minimalist” to describe it. As he has said, it will give the Treasury the power to require the FSCS to provide information, so that the whole of Government accounts may be prepared. It will also give the Treasury the power to demand information within a specified period.

It is vital that the FSCS provides accurate information on time and on the basis the Minister described. However, I am unclear as to what timetable he has in mind for providing such information. Will he give us some details about that? The Minister stressed that the Treasury does not intend to undermine in any way the independence of the scheme or to interfere with its day-to-day running and responsibilities, but it is important to ensure that safeguards are in place in case the scheme does not run correctly. Will any sanction be available should the FSCS not provide sufficient information within the time scales agreed or set out?

Will the Minister describe what regular meetings are held between the Treasury and the senior management of the scheme as part of the regular oversight or supervision of the FSCS? Who is involved in them? How often do they take place? How do they operate? Will regular meetings be held with the FSCS, the Financial Conduct Authority and the Prudential Regulation Authority as part of the ongoing oversight and dialogue? It will be helpful for us to understand that in the context of ensuring that the scheme runs appropriately and that there is oversight and accountability.

Greg Clark (Conservative, Tunbridge Wells)

The clause refers to information that can be reasonably required

“in connection with the duties of the Treasury under the Government Resources and Accounts Act 2000”,

which limits the type of information that may be required. That also has implications for the timing involved in providing the required information.

The time requirements relate to the type of information required. For example, financial accounts are required annually. The scheme manager and the Treasury will be required to agree on a consolidation timetable each year, whereby the scheme manager will provide the financial information in an agreed format for consolidation into the Treasury’s accounts. As a minimum, it should include accounting data in a usable format on a quarterly basis and a complete set of account information at the end of March.

It is envisaged that the scheme manager will provide the Treasury with forecast information in an agreed format twice a year, so that parliamentary estimates may be made and presented to the House. The information for that purpose will be required by the end of January for the main estimate and by the end of December for the supplementary estimate. Returns from the FSCS will consist of a summary of its forecast resource and capital expenditure, aligned to the Government’s financial year.

The final piece of information that we anticipate requiring using this power is monthly management information to support the Treasury principal accounting officer’s assurance over the consolidation of the FSCS accounts into the Treasury group’s consolidated account. The accounting officer of the FSCS will be accountable to the Treasury’s accounting officer. They will report in that way and also directly to Parliament. As for an available sanction, across Government, accounting officers obey the directions of other accounting officers when there are subsidiaries, but in extremis I am advised that a court order could be imposed on the accounting officer of the scheme to comply. Much scarier than the order of a court is the wrath of the Public Accounts Committee should that not happen.

Nick Smith (Labour, Blaenau Gwent)

I want to follow up the question that my hon. Friend the Member for Kilmarnock and Loudoun asked about the whole of Government accounts. It is an important tool, not just for the PAC but for all those who are interested in Government expenditure. It is not clear from his answer how quickly the information that could help the whole of Government accounts will be provided by the organisation.

Greg Clark (Conservative, Tunbridge Wells)

The requirement is that it is done in a timely way for the presentation of the accounts to the National Audit Office and the PAC. The reason for specifying the Government Resources and Accounts Act 2000 is that the powers can then comply with the Treasury’s requirements in that respect. There are regular meetings between the Treasury and the FSCS, and senior officials meet the FSCS chief executive approximately every two months. Treasury finance officials also meet the FSCS finance director, and the chief executive, Mark Neale, is someone whom I have met twice personally in the past few months.

Clause 12 - Scheme manager: appointment of accounting officer

Greg Clark (Conservative, Tunbridge Wells)

This brings us to the end of the group of clauses relating to the FSCS. I anticipated some of the points relating to this clause in my earlier remarks. The Office for National Statistics has reclassified the FSCS as a central Government body. As such, its accounts have to be consolidated in the Treasury group accounts. Each organisation in central Government must have an accounting officer. The accounting officer, as Members know, is someone who can be called to Parliament and held to account for the stewardship of resources within the organisation’s control. Clause 12 provides for the first time for the statutory appointment of the chief executive of the FSCS scheme manager as an accounting officer. The current chief executive is Mark Neale. The clause also ensures that the Treasury must approve the appointment of the chief executive.

As an accounting officer, the chief executive is personally responsible for safeguarding the public funds of which he or she is in charge. In the case of the FSCS, that takes the form of levies on the financial services industry. The chief executive is also personally responsible for ensuring that, subject to his or her duties under FSMA and the Companies Act 2006, the FSCS as a whole is run on the basis of the standards on governance, decision making and financial management that are set out in “Managing Public Money”. The statutory appointment of the chief executive as accounting officer will strengthen the FSCS. It is consistent with the reclassification of the body by the ONS. It represents an increased level of accountability to Parliament. I think it will help to provide the confidence that the Treasury needs in the regularity and propriety of the whole of the Treasury group account.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

We have had some discussion on this in the light of the issues that were raised in clause 10.

Peter Bone (Conservative, Wellingborough)

Before the Committee resumes, it might be helpful if I remind Members that the deadline for tabling amendments for the next sitting, which is on Tuesday 16 April, is 4.30 pm on the previous Thursday, 11 April.

Cathy Jamieson (Labour, Kilmarnock and Loudoun)

It is a pleasure to serve under your chairmanship again this afternoon, Mr Bone. When we adjourned just before lunchtime, I was in the process of saying that I would not prolong this stand part debate, and I intend to stick to that. I seek merely to make a few points on the Minister’s comments in relation to clause 10, and I seek further information on the record.

For the benefit of those who have had exciting things to do over the intervening period and have perhaps forgotten that we reached clause 12, which is on the appointment of an accounting officer—the Financial Services Compensation Scheme chief executive—I briefly remind hon. Members that the clause amends the Financial Services and Markets Act 2000 to ensure that the FSCS constitution provides for the chief executive, as the Minister outlined. He also made it clear that the FSCS chief executive will be the organisation’s accounting officer and will sit on the board alongside the chairman. I had some questions on the line of accountability from the accounting officer to the Treasury, but to be fair, he addressed some of that when we considered clause 10.

The chief executive will be appointed by the Prudential Regulation Authority and the Financial Conduct Authority. If I understand the Minister correctly, the Treasury will have to approve the appointment. That answers one of my questions, but it begs the question in what circumstances the Treasury would see fit not to approve an appointment recommended by the PRA and the FCA. In that circumstance, who would have the final say? What would the procedure be if the PRA and the FCA were unable to reach an agreement in some hypothetical situation, or if they were to favour different candidates? It would be helpful if the Minister responded to those points.

The Minister addressed some of this when we considered clause 10, but it would also be helpful if he reminded the Committee of the circumstances that might lead to the removal of the chief executive and the procedures through which such a decision would be approved by the Treasury. I work on the assumption that, if the Treasury has to approve the appointment, it will also have some say in the chief executive’s removal.

Greg Clark (Conservative, Tunbridge Wells)

I will attempt to refer to the hon. Lady’s points. There are no changes to the arrangements for the appointment of the FSCS chief executive. The designation of FSCS accounting officer will simply be an addition to the chief executive’s current responsibilities, just as, at the moment, the Treasury and the regulators must have confidence in the chief executive on appointment.

On the circumstances in which it might not be seen fit to appoint an individual, it is hard to imagine that the FCA and the PRA might recommend someone who did not meet with the Treasury’s favour. Having said that, if the accounting officer becomes, in effect, a subordinate accounting officer to the Treasury’s accounting officer, it is only reasonable for the concerns of the latter to be addressed if they have no confidence in the other’s ability to discharge their strict responsibilities as an accounting officer under another accounting officer. The PRA and the FCA have a memorandum of understanding that governs their relationship. We would expect them to seek agreement on these matters and, through negotiation, reach a sensible outcome. I cannot see circumstances in which the Treasury’s right of veto in this regard would regularly and routinely used. It would be used in exceptional circumstances where the accounting officer of the Treasury did not feel that the person below him or her in the hierarchy was capable of discharging those functions.

On the removal of the accounting officer, both the appointment and removal would need to be approved by the Treasury, but of course the chairman of the PRA would be responsible for initiating procedures if, on behalf of the organisation, they felt that the chief executive was not doing the right job.

Clause 13 - Fees to meet Treasury expenditure relating to international organisations

Greg Clark (Conservative, Tunbridge Wells)

I think that most Committee members would agree that the cost of dealing with the failure of banks—indeed, the regulation of financial services—should fall on the sector rather than on ordinary taxpayers. That principle is followed in the FCA and the PRA, which are financed by a levy on the industry, which was established in the Financial Services Act 2012. Other regulators can cover the costs of their international work from the industry, but it is an anomaly that so far the Treasury is not able to meet its costs.

The clause is restrictive about those costs. Tempting though it is, this is not a mechanism to fill the coffers of the Treasury and finance all sorts of imperialistic tendencies that it might fall prey to. It is limited to the expenses that come from certain prescribed organisations, which I will mention, that need to be specified to Parliament. The costs are limited to the membership of organisations set out in proposed new section 410A(2) of the 2000 Act. It is proposed that only the global Financial Stability Board should be named from the outset. Any other organisations that would be added in future must have a role in the scrutiny and promotion of financial stability of financial services. Currently, the FSB does not levy a charge on its constituent members—it is funded by the Bank for International Settlements—but in future it may introduce membership fees. The clause is forward-looking and would prevent the Government’s having to return to get primary legislation if, in future, that body started to levy charges.

We have published draft regulations already and will consult the Bank, the PRA and the FCA about who should be subject to fees. For example, there is a question about whether the insurance sector might need to be covered or ought to be exempt. However, the power in the clause is relatively straightforward.

Chris Leslie (Labour, Nottingham East)

The “imperialistic tendencies” of the Treasury imply that there is an emperor somewhere within. I do not know whether there is a Napoleon complex or something else that we should explore there, but I will set that to one side.

It clearly makes a degree of sense for the Treasury to be able to recoup some of the expenses related to the membership of various international organisations. I might have missed it or misheard the Minister, but I do not think that he listed the international organisations in question—it is all very well saying, “For example, the Financial Stability Board or the Basel Committee on Banking Supervision,” but are there others?

Greg Clark (Conservative, Tunbridge Wells)

There is only one. Only the Financial Stability Board is specified from the outset, and currently it does not charge fees.

Chris Leslie (Labour, Nottingham East)

That answers my next question, which was about how much the fees are. I want to take the opportunity to ask the Minister about some of the fees that the Treasury has to pay to international organisations. We have recently spotted that the fees for international financial organisations that should have been attributed to the financial year 2012-13 are actually budgeted for the next financial year. For example, under the rather ambiguous title “Exceptional inter-period flexibility”, to which the Chancellor referred in his Budget speech, we saw that the fees for the World Bank and other organisations such as the United Nations and some EU institutions may well have been cast into 2013-14. That raises questions about whether we will have to affiliate twice in that one financial year.

In particular, the UK’s contribution to the European Investment Bank was reclassified. That mysteriously appeared on page 130 of the Office for Budget Responsibility report, yet there was no rationale explaining who made that decision, when or for what purpose. However, it handily reduces the spending totals for 2012-13. I am sure that the Treasury did not resist that too much. We must keep a little watch on what is going on with these fees and subscriptions to international institutions.

If I were one of those institutions, I would be wary of doing a deal with the current occupants of the Treasury, considering their “imperialist tendencies,” because they do that thing where they say, “The cheque is in the post. Don’t worry, we will pay your fee for 2012-13.” Whether they are actually posting the envelope containing the cheque is another matter.

I was told many years ago—obviously I never actually sought to undertake this practice—that if one folds a cheque before paying it, somehow it takes an extra day to clear because a folded cheque does not go through the machines in the clearing system rapidly enough. Has the Chancellor taken to folding his cheques down the middle just to kick the borrowing figures one year further down the road? That is the questions that the Financial Stability Board and the Basel Committee may well need to ask.

I know that there are currently no fees, but this is quite an important issue given what is happening. If there are new organisations that are likely to charge fees, it would be helpful to know what they are and whether there would be proper, normal conventions on how they should be paid or whether we be going into the dimension of inter-period extraordinary flexibility.

Greg Clark (Conservative, Tunbridge Wells)

I know that the hon. Gentleman used to represent a Yorkshire constituency; I do not know whether that is where he learnt this trick of folding cheques to have an extra day’s interest. As a Yorkshireman myself, I am sure that God’s own county would be proud of his little contribution to financial efficiency. I cannot quite work out whether he is concerned that these powers are going to give occasion to let the Treasury rip with the public finances, or thinks that we are too mean in paying our expenses to international bodies.

Remarkably, the Treasury, as befits its reputation, manages to have most of the subscriptions to international bodies paid for by other organisations, whether it is the regulators or other Government Departments, so the occasion to fold up the cheques that are in the post is limited. However, we see coming down the road a particular bill that might be presented from the global Financial Stability Board. With characteristic alacrity, seeing the impending bill that might be presented, the Treasury has anticipated it and taken action so that the cheque can be forwarded straight on to the industry to be picked up. I am not aware of any other financial organisations that need to be designated so that fees are incurred. Certainly there are none that we intend to be covered by the Bill. I have a note about all sorts of organisations that the Bank of England and the FSA pay subscriptions to, but I am delighted to say that the Treasury is not part of it.

Clause 14 - Amendments of section 429 of FSMA 2000

Greg Clark (Conservative, Tunbridge Wells)

This is a technical clause, which sets out the parliamentary procedure that will apply to regulations made under new sections 142K and 410A of FSMA on funding for international organisations. It sets out that the affirmative resolution procedure will be used for all regulations, except those that only specify the name of an international organisation that comes within the scope of new section 410A, which will be subject to the negative resolution procedure.

The list of international organisations will be technical in nature. The reason why the negative resolution procedure is preferred is that some international organisations—in fact, the Financial Stability Board is the only one—have been known to change their names from time to time. The FSB was renamed from the Financial Stability Forum. Very occasionally, it will be necessary to tweak a name on the list, and that is the reason for the negative procedure. I hope that satisfies the Committee.

Chris Leslie (Labour, Nottingham East)

I do not object to the technical nature of the clause. I am just perplexed that we need the provision for negative statutory instruments just because of a potential name change, which I would have thought would apply to a number of different aspects of the Bill. It would be useful, if we will not have an opportunity through the affirmative procedure to study and scrutinise the payment of the fees for international institutions—a negative resolution is a bit insubstantial—for the Minister to commit to a written ministerial statement if and when those sums become apparent, so that at least we can flag them up to the House. It is a shame that we will not have them all under the affirmative procedure. Otherwise, the Minister is almost in a good place on the matter.

Greg Clark (Conservative, Tunbridge Wells)

I have no objection to that at all. It seems a very sensible way of keeping the House informed, and I am happy to commit to it.

Clause 15 - Accounts of Bank of England and its wholly-owned subsidiaries

Greg Clark (Conservative, Tunbridge Wells)

Sometimes, in financial crises, swift, decisive action is needed to support one or more institutions. The Bank of England, as the UK’s resolution authority, may be called on to provide financial support to an institution in an emergency. When it does so, it may choose to create a special purpose vehicle separate from the bank’s own balance sheet, for the purposes of good order. Clause 15 will allow the Bank to direct such wholly owned subsidiaries to disregard the disclosure requirements under the Companies Act 2006. The reason for avoiding the disclosure of information is that the provision of liquidity assistance, for example, could need to be covert in order to prevent a witch hunt to discover which institution is being aided in that way.

The use of the power specifically requires that it must be necessary, not just convenient, to meet the financial stability objective. That is quite a rigorous test. The norm, rightly, is that disclosure should be the default and not simply a matter of whim or volition on the part of the Bank to hide the flows of funds. The test is that the use of the power must be necessary to meet the financial stability objective. The Treasury must be consulted, and can if it wishes compel disclosure, overriding the Bank’s own view.

As Committee members will know, there is a crisis management memorandum of understanding between the Bank and the Treasury. That MOU requires that in any circumstances of emergency assistance, the Chancellor must tell the Chairs of the Treasury Committee and the Public Accounts Committee that action is being taken, notwithstanding the fact that it is not in the public domain. The Chancellor has a responsibility through the MOU to keep Parliament informed. A draft of the MOU is published and is available for scrutiny by Parliament. The MOU for these purposes is between the Bank, the Treasury and the PRA.

I hope that the provisions of the clause will commend themselves to the Committee. As I said, they are for use in exceptional circumstances and are subject to a rigorous test that they are necessary for financial stability.

Chris Leslie (Labour, Nottingham East)

This is a slightly unusual, eyebrow-raising clause. Obviously, the Bank of England operates a rather mysterious part of our constitution generally. It is the magic money tree that the Prime Minister said he did not want to use in his infamous speech the other day, and it has been tempting for the Chancellor to shake it occasionally, creating money. The process has left many people scratching their heads about how it works.

Setting that aside, it is important that many of the normal conventions of company law, transparency and accountability apply to the work of the Bank of England. After all, the Chancellor will essentially be vesting all the aspirations of his aspiration nation in the new Governor, Mark Carney, when he arrives, trusting and hoping that he will ride to the rescue of the economy. We must keep an eye on what is happening with monetary policy more broadly. Clause 15 is one of those interesting little clauses that are worth peeking inside.

I do not think there are existing subsidiaries of the Bank of England that are already long standing, although maybe there are. It is often the case that large entities have dormant subsidiaries or other sub-company structures. I am not sure whether there is anything at present other than the Bank of England that is incorporated, or whether it has subsidiaries that might fall within the scope of the amendment. I understand what the Minister says about the need in a crisis, for commercial sensitivity reasons, not to have instant disclosure and availability of some of our inter-financial interventions, but a strong dose of ex post scrutiny is necessary once the tide has subsided a little, just to go over what the intervention was.

Will the Minister assure the Committee that although the normal company law scrutiny arrangements will not apply in these exceptional circumstances, there would still be a general expectation on the Bank of England to make a report? I am not sure how many years down the track that should be—perhaps not quite a 30-year rule; but it would be appropriate if two, three or four years later, once the crisis has subsided, we could know about the liquidity injections and other forms of assistance that might have been hidden beneath the protection of exclusion from company law availability. Those are my main anxieties. In particular, there should be an opportunity for ex post scrutiny further down the track.

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman makes perfectly reasonable points. The Bank’s arrangements are that when it is called upon to give this assistance, it tends to create a special purpose vehicle as a wholly owned subsidiary of the Bank in order to section it from the rest of the Bank’s activities. Such vehicles would be wound up when no longer needed. They have been needed in the past: for example, the emergency liquidity assistance provided to Royal Bank of Scotland during the last crisis is a good case. Knowledge at the time that such assistance was being provided might have occasioned an even more rapid, and possibly even more disorderly, consequence than the unfortunate one that resulted, and it is possible to imagine such circumstances in the future.

The clause is restrictive in that it can be used simply for narrow circumstances. It is not available, for example, to hide some of the monetary policy mechanisms that the Bank might use. They have to be disclosed in the normal way.

The point that the hon. Gentleman makes about ex post scrutiny is absolutely right. The Chairs of the Public Accounts Committee and the Treasury Committee will know immediately, but the memorandum of understanding, which is published between the Treasury, the Bank and the PRA, explicitly requires that such information will be laid before Parliament when the Treasury, having consulted the Bank, has decided that the need for confidentiality of the support operation has passed. The requirement is to consider and keep under review when that confidentiality requirement has passed. In some cases it might be a matter of months, but in other cases it might be more than that.

Clause 16 - Orders and regulations

Chris Leslie (Labour, Nottingham East)

I beg to move amendment 30, in clause 16, page 20, line 28, after ‘ring-fencing)’ insert

‘or section (Bank bail-in regime)(2) (bank bail-in regime)’.

Peter Bone (Conservative, Wellingborough)

With this it will be convenient to discuss the following:

New clause 19—Bank bail-in regime—

‘(1) The Bank of England must, at least once in every year, prepare an assessment of any progress which has been made towards the introduction of a bank bail-in regime in the United Kingdom or, once a bank bail-in regime has been introduced, of its operation.

(2) If a bank bail-in regime is not in force in the United Kingdom by the end of 2015, the Treasury must by regulations make provision for such a regime.

(3) an assessment under subsection (1) must include—

(a) an assessment of how much of the issued debt of banks would be covered by any proposed bank bail-in regime or is covered by the provisions of the bank bail-in regime in force;

(b) (if a bank bail-in regime is in force) an account of the sorts of companies within groups which have creditors who are covered by the bank bail-in regime and of the sorts of persons who are creditors who are so covered;

(c) a review of the descriptions of creditors who would be covered by any proposed bail-in regime or are covered by the provisions of the bank bail-in regime in force, and

(d) an account of progress towards international co-operation in relation to bail-in regimes.

(4) The Bank of England must send the assessment to the Treasury.

(5) The Treasury must lay the assessment before Parliament.

(6) The Bank of England must publish the assessment in such manner as they think fit.

(7) In this section “bank bail-in regime” means provisions under which losses incurred by a bank are to be met by certain descriptions of creditors of the bank should the bank encounter financial difficulties which might otherwise lead to the taking of action which would be likely to have implications for public funds.

(8) For the purposes of subsection (7) “action having implications for public funds” has the same meaning as in section 78(1) of the Banking Act 2009.

(9) In this section “bank” means a UK institution which has permission under Part 4A of FSMA 2000 to carry on the regulated activity of accepting deposits, other than a building society (within the meaning of the Building Societies Act 1986) or any description of institution excluded by virtue of subsection (2)(b) of section 142A of that Act from being a ring-fenced body as defined in subsection (1) of that section.’.

Amendment 31, in title, line 4, after ‘insolvency;’, insert

‘to make provision in relation to a bank bail-in regime;’.

Chris Leslie (Labour, Nottingham East)

The amendments relate to the bail-in regime. We talked a little about the potential of bail-in arrangements earlier when looking at the preference given to depositors, but having seen the dreadful events in Cyprus, the issue has become more serious, with more popular understanding of what could befall depositors in a bank if there are particular difficulties. The amendments would provide for a bank bail-in tool to be created in the event of a bank finding itself in financial difficulties, and would ensure that there was a process for creating a bail-in arrangement that is robust and able to cope with a number of different circumstances.

Our principal change would be to amend clause 16 to allow the addition of new clause 19, which would ensure that every year the Bank of England prepared

“an assessment of any progress which has been made towards the introduction of a bank bail-in regime in the United Kingdom or, once a bank bail-in regime has been introduced, of its operation.”

New clause 19 would also ensure that proper assessment was undertaken by the Bank, particularly in respect of how much of the issued debt of banks would be covered by any proposed bail-in regime, and would make sure that such a review considered the sorts of persons who are creditors to be covered by that scheme. The Bank of England would then forward the assessment to the Treasury, which in turn would lay it before Parliament, so that the Bank and others could respond in due course.

The Parliamentary Commission on Banking Standards helped to inspire this group of amendments. It was very concerned that the Bill had been brought forward without an adequate bail-in arrangement. That is why we find ourselves in this slightly unusual terrain—I do not think that I have encountered this situation before in my many years of service on Bill Committees—where we are proposing an amendment not to a clause, but to the long title of the Bill. I am assured that we sometimes discuss the long title in Committee, at the very end: the long title would need to be amended to make the scope of the Bill cover the provisions in new clause 19; amendment 31 is therefore consequential to the new clause.

Even after ring-fencing, the failure of a large bank could still pose a risk to public funds. Both ring-fenced and investment banks have the potential to shake financial stability, which is why the Parliamentary Commission was so keen to advance a bail-in regime that would apply to both ring-fenced and investment banks. A bail-in regime is a regulatory tool that allows bonds to be converted into capital when a bank is in financial difficulty, which would allow for the resolution of banks without recourse to the public purse. It would work by capitalising a bank through the conversion of debt into equity or through debt write-down; it would occur when a bank is put into resolution, and so would need to be triggered by the regulator. It could allow some of the bank’s operations to continue as a going concern, or could facilitate a solvent wind-down in resolution. There is a growing feeling that the banks and the bankers obviously contributed significantly, or even wholly, to the financial crisis and left the taxpayer to bear the burden. A bail-in tool would help to prevent that from happening in the future.

As I understand it, the Government have accepted the principle of the bail-in. However—and this is a pity—they seem to have been dragging their heels a bit, not just in failing to put such an arrangement in the Bill but in the way in which they have been waiting for the European Union to determine this particular set of rules through the recovery and resolution directive—a directive that might not have been that well known until recent weeks. Events can move at great speed but, as we know, there is always the possibility with European legislation that it might take a phenomenal amount of time. Especially given the situation in Cyprus, there could well be wrangling and disagreements about how the process will work for quite a long time to come. I therefore think that Britain needs to settle its own bail-in arrangements at the earliest possible opportunity. It would be far better for us to have our home-grown variant. If Europe follows later down the line, let them follow where we have led, in my humble opinion.

The introduction of a bail-in regime would mean that a resolution of a failing bank could be carried out in just days, such as over a weekend, rather than over weeks, as we have seen in Cyprus. It would be far better to prepare and think about such things in advance. Hopefully the scenario will never occur, but a stitch in time saves nine, as my mother always said.

HSBC’s evidence states that

“while ring-fencing adds clarity to different parts of the banking model and makes explicit the risks being borne by creditors to each portion, it has less practical impact on the ‘sorting out’ of failed banks: it is financial bail-in which provides the solvency support to allow for a more considered restructuring of the firms at the necessary granular level using the information from the resolution planning process rather than the structural separation of activities.”

The Parliamentary Commission commented:

“An effective and credible bail-in tool would represent a major step towards eliminating the implicit guarantee and ensuring that the costs of resolving a failing bank are not borne by the taxpayer. It is notable that bail-in is at the heart of the resolution strategies currently being designed for large systemically important banks, and will remain important even after the ring-fence is introduced.”

If the Government want to introduce a bail-in regime, now is the time to be getting on with it. Some paving provisions in the Bill would be sensible and prudent. Sitting back, not taking the opportunity, and waiting for the European Union to resolve the issue is not necessarily the wisest course of action. It would be better for us to shape our own destiny on such issues.

As the Parliamentary Commission highlighted, there are significant risks that the EU-wide measures could be watered down and delayed, and the measures really ought to be in place by the end of 2015. Standard Chartered bank, whose chief executive is Peter Sands, said:

“We strongly urge the Government to adopt a statutory regime for the application of bail-in covering all existing senior unsecured debt in issue irrespective of residual maturity. We believe this provides a good foundation for a global regime.”

Sir John Vickers, who also gave evidence to the Commission, said that he believed that a European solution was possible but agreed that the UK should implement such a change in national legislation “in any event”. Even the august incoming Governor of the Bank of England, Mark Carney—for it is he—acknowledged that, on its own, the ring-fencing arrangements would not be sufficient. He described the creation of a credible bail-in mechanism as critical and essential to prevent taxpayers from being on the hook.

When the Commission says to the Minister that Parliament needs assurances that bail-in is not a paper tiger—markets need that assurance too—the Bank of England’s role to report on the development and functioning of the bail-in arrangement is an important recommendation. I hope that the Minister will accept that.

In our view, the report should include: the quantity and issue of debt, which can easily be subject to bail-in; whether bail-in-able debt is being issued over the correct part of the banking group; the distribution of holdings of bail-in-able bank debt in the rest of the financial system; and the feasibility of ways to bail in creditors beyond long-term unsecured bonds such as corporate depositors, uninsured household depositors and derivative counterparties. We would also like the report to include progress on tackling global legal barriers that might exist to the recognition of bail-in regimes.

Given the size of the UK’s financial sector, which makes up an estimated 75% of the EU’s financial services sector, taxpayers here face higher levels of risk than elsewhere in Europe. The implementation of a bail-in mechanism is therefore particularly important in our own jurisdiction. It is important that the Government show that steps are being taken before 2015 so that we can make some progress. I do not see any excuse for not doing what the Commission has recommended, and I commend its arguments to the Committee.

Greg Clark (Conservative, Tunbridge Wells)

I have a great deal of sympathy for the arguments of the Commission and the case that the hon. Gentleman put. Bail-in is incredibly important and the events of the past couple of weeks in Cyprus emphasise the importance of having sure knowledge in advance of what happens in the event of failure, and of which creditors are in line to have their capital bailed in to help a bank be resolved. The confusion of recent days reinforces the case for that knowledge.

Recent events also underline the importance of the international perspective. Even in a small country such as Cyprus, the international spread of banks raised questions for other jurisdictions, particularly for Greece. There are discussions about the resolution of the Greek branches, which are particularly exposed to both economies. International arrangements, given the international nature of some of the banks, are the first best solution. They commend themselves, and we should aim for them.

My reservations about the amendment are not to do with the desirability of having bail-in provisions. It is important that there should be those and that they are credible and reliably cover the kinds of creditors that need to be bailed in.

On the negotiations on the recovery resolution directive, the hon. Gentleman implied that we were the passive recipients of whatever comes out of Europe, but we feel particularly strongly about the issue for all the reasons that he identified. Most people in the EU would concede that we are one of the driving forces behind the dossier and its progress. I do not know about you, Mr Bone, but I spent my lunchtime looking at a note on the progress that we are making on the resolution and recovery directive, such is our constant desire to move it forward.

We are making progress. The Irish presidency of the EU has prioritised completion of the resolution and recovery directive and good progress is being made. Given that the Independent Commission on Banking recommended that the bail-in power should not come in until 2019, we see every prospect that it will be agreed at the European level well in advance of that. We hope to secure agreement under the Irish presidency, for which the issue is a priority.

Members of the ICB gave advice to the Parliamentary Commission. Martin Taylor, who was a member of the ICB, said:

“A common international standard is also very desirable. If we can do that through the European work, that would be the best answer”.

Sir John Vickers, whom the hon. Gentleman quoted, said that he had

“no reason to think that the European processes would move as slowly”

as to require a separate approach. That continues to be our assessment, but the question is reasonable—what would happen if that stalled and our ambitions, expectations and the sacrifice of our lunch hours were in vain and we were not able to secure progress? Given that the Irish presidency lasts until June, we will certainly know on Report in the Commons how well we are progressing. By the time the Bill reaches the House of Lords, we will have a clear idea of whether the matter has been agreed.

My preference would be to consider the issue at that stage, rather than to establish a mechanism that triggers a review; agreement at a European level is identified by most commentators as being the most desirable outcome. If we are unable to agree, we will know that relatively soon, while the Bill is before Parliament. We could reflect then on the measures that we could include in the Bill to make sure that we had a credible bail-in mechanism that, for all the reasons the hon. Gentleman identified, is very necessary.

Chris Leslie (Labour, Nottingham East)

I am glad to hear that the Minister spent his lunchtime looking over the resolution recovery directive papers that the Irish presidency had approved. I do not know whether he had the spaghetti bolognese on offer in the Members’ Tea Room—100% beef, I am assured. It must be fun to dine with the Minister on occasion, although perhaps not today.

The Minister makes a point about waiting to see how the European arrangements progress and says that Britain can be in the driving seat of the resolution recovery directive. I hope so too, given the size of our financial sector relative to the remainder of the European Union.

I happen to think that the bail-in arrangements are mission-critical—not just to our future as a financial services industrial sector, but to the economic well-being of a nation state in its own right. Saying, “Well, we hope that these will come into force well in advance of 2019” does not quite cut it—that is six years from now. “Well in advance”? How long is a piece of string? We should make efforts to think these things through for ourselves and make progress under our own steam now. We do not know what is around the corner. Say, for the sake of argument, the eurozone situation becomes even more of a swirling morass. It is difficult to envisage what situations could occur.

To be prepared, it would be better to kick off rather than say, “Let’s wait until June and see how well the Irish have done.” I am not sure who is taking over the presidency after the Irish; perhaps the Minister can let us know. What I am saying is perfectly realistic. It is not asking a massive amount to say that the Bank of England should be encouraged to assess the progress being made towards introducing an adequate bail-in regime. That is all new clause 19 would do, incidentally; it does not specify the full details and dimensions of what that bail-in process would do. It just puts a needle into the Bill that says, “Come on. Let’s encourage this process. Let’s move it forward that little bit more.” That would be a worthwhile area for the Bill to cover. The Parliamentary Commission has expressed strong views on the issue.

Greg Clark (Conservative, Tunbridge Wells)

As I said, we expect the EU negotiations to make progress during the life of the Bill in Parliament. If they failed to do so, against our expectations, we would want the Bill to reflect that.

If we accepted the new clause, we could end up with a paradoxical situation. We would have a requirement for the Bank of England to review within a year after Royal Assent, which is some months ahead, something that duplicated an aspect that we might have addressed with immediate effect. Far from advancing the discussion, it would be a curious and eccentric provision in the Bill to require a review of something that had already been addressed and whose powers had already been provided for.

Chris Leslie (Labour, Nottingham East)

That might not be the case. By extension, if further developments had taken place, it would be possible to remove the provision on Report or in the other place as the Bill progressed. Including the new clause would be a stitch in time to make it clear that bail-in is incredibly important.

The Commission has very strong views, and those who expressed their views in evidence to the Commission also felt that we need to move things forward rather than taking a wait-and-see approach. Such an approach might have been appropriate before Cyprus, but that situation is a wake-up call that we cannot ignore. I would like to press amendment 30 to a vote to make that point.

Greg Clark (Conservative, Tunbridge Wells)

Clause 16 provides that the Treasury shall exercise by statutory instrument the powers conferred on it by the Bill. That is the standard way in which powers given to the Government to make delegated legislation are exercised.

The clause also provides that the affirmative procedure should be used in relation to regulations made under clause 8, which we discussed earlier today, applying ring-fencing provisions to building societies. The affirmative procedure is used because the power given in clause 8 will permit the Treasury to amend primary legislation—in particular, the Building Societies Act 1986.

Subsection (3) of clause 16 sets out the parliamentary procedure that applies to orders made under clause 18, which permits the Treasury to make transitional or savings provisions in connection with the commencement of any provision in the Bill. In general, such orders will be subject to the negative procedure, as is usual for this class of statutory instrument. However, where provisions made under clause 18 will be included in the same statutory instrument as provisions made under sections that are subject to the affirmative procedure, they will also be subject to the affirmative procedure. That is necessary to enable provisions under clause 18 and other enabling powers in the Bill to be included in the same statutory instrument.

Peter Bone (Conservative, Wellingborough)

With the leave of the Committee, we will take clause 17 stand part with clauses 18 to 20 stand part, unless any Committee member wishes to speak separately to clause 19, in which case I propose that we take clauses 17 and 18 stand part together.

Chris Leslie (Labour, Nottingham East)

I have one question for the Minister on one of those clauses.

Peter Bone (Conservative, Wellingborough)

We can debate them together. Is that okay with the Committee? I call the Minister.

Greg Clark (Conservative, Tunbridge Wells)

This is an unexpected development, Mr Bone. I will describe the principle of clause 17—

Peter Bone (Conservative, Wellingborough)

Order. Just so that the Minister is clear, what we have just decided is that we will debate clauses 17 to 20 stand part together and then deal with them at the end of the debate.

Clause 17 - Interpretation

Peter Bone (Conservative, Wellingborough)

With this it will be convenient to discuss clauses 18 to 20 stand part.

Greg Clark (Conservative, Tunbridge Wells)

Clause 17 is quickly dealt with. It defines key terms that are known to members of the Committee, such as the FCA and the PRA, and it defines enactment for the purposes of the Bill.

Clause 18 makes provision for the transitional arrangements to the new system. Members will agree that it is essential that the transition to ring-fencing be as seamless as possible to reduce uncertainty to firms in the financial services industry and their customers. The clause enables transitional orders to be made to provide, in particular, for the regulators to take such steps as are necessary in the lead-up to commencement, to enable them to exercise their powers on or after the day of commencement. The Delegated Powers and Regulatory Reform Committee is content with the provisions’ using the negative procedure.

Clause 19 sets out the territorial extent of the Bill; there was a conversation earlier with the hon. Member for Foyle. The provisions apply to England, Wales, Scotland and Northern Ireland—with the exception of making depositors preferred creditors, because the insolvency arrangements apply only to Great Britain and not to Northern Ireland; insolvency is not a reserved matter with respect to Northern Ireland. The Northern Ireland Assembly has indicated that it intends to introduce depositor preference through its own Bill on insolvency.

Clause 20 deals with the commencement of the Bill. It gives the Treasury the power to bring clauses 1 to 15 into force by commencement order and to specify different days for different provisions to come into force. Members will be aware that Sir John Vickers and the Independent Commission on Banking set the start of 2019 as the deadline by which their recommendations should be in place. That was because they recognised that there was a balance between the costs and the organisational complexity of introducing ring-fencing. [Interruption.]

Peter Bone (Conservative, Wellingborough)

Order. There is a Division in the House. The sitting will be suspended for 15 minutes.

Greg Clark (Conservative, Tunbridge Wells)

As I was saying, the Government agree with the timetable proposed by Sir John Vickers, which is in line with the Basel III timetable. Banks will be required to be ring-fenced no later than 2019. The provisions of the Bill relating to ring-fencing will be brought into force in sufficient time to allow that to happen. Depositor preference will be brought into force according to the same timetable.

Chris Leslie (Labour, Nottingham East)

I have a simple question on clause 17. Will the Minister give us a sense of when he expects the Bill to receive Royal Assent? Will it be by the end of 2013? What timetable does the Bill team currently envisage?

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman tempts me into territory into which I would be ill-advised to go, since Members of the House of Lords strongly guard their ability to scrutinise the legislation that comes before them and to take whatever time they need to scrutinise it. We certainly want to make important progress with the Bill, because everything needs to be in place by 2015, including the statutory instruments. The best I can do is remind the hon. Gentleman that this is a carry-over Bill, so the requirement is that it should be completed within a year of introduction, which is what the Chancellor said. That takes us to, at the latest, February 2014.

New Clause 1 - Leverage ratio

Chris Leslie (Labour, Nottingham East)

I beg to move, That the clause be read a Second time.

We now reach the Opposition new clauses, some of which were tabled on behalf of the Parliamentary Commission. As we said on Second Reading, the problem with the Bill is that it is very much a shell, which is to be populated with substantive measures. The Opposition are frustrated that the Government have not waited for the Parliamentary Commission to make full recommendations about the standards, culture and governance improvements that are needed in the banking sector.

New clause 1 would give the Treasury clear order-making powers in relation to leverage ratios in the banking sector. The Parliamentary Commission was certainly very forceful on this issue, but Sir John Vickers’s commission, which reported the year before, was even more concerned to impress the importance of the issue on policy makers. A bank’s leverage is the ratio of its assets to its equity capital. Its equity is equal to the value of its assets minus the value of its liabilities. Higher leverage rates magnify returns, because any growth in assets will be proportionately greater if the bank’s equity is thin. However, the corollary is that any losses are also magnified if leverage is greater. A bank’s equity can be wiped out by a smaller shock than would wipe out the equity of a less leveraged institution. Two banks with the same ratio of capital to risk-weighted assets, or RWAs, might easily have different leverage ratios.

The Government have said that they intend to provide the Financial Policy Committee of the Bank of England with a time-varying leverage ratio tool, but they do not want to do that before 2018. In the Opposition’s view, that is inadequate. The Government’s view would be subject to review in 2017, to assess progress internationally. Ministers say that they want to leave these things to other international institutions to determine, but Sir John Vickers’s commission made it clear in its report that it

“supports the use of leverage ratios as a backstop, and recommends that all UK-headquartered banks should be required to operate with a minimum Tier 1 leverage ratio of at least 3% (and would favour international agreement on a higher ratio). Further, all ring-fenced banks should meet this requirement on a solo basis.”

The commission went on to call for a tapering of the requirements

“when a bank crosses a size threshold…by increasing the minimum leverage ratio from 3% to 4.06% on a sliding scale as the RWAs-to-UK GDP ratio increases from 1% to 3%.”

Reforms are needed not only to leverage, but to the risk weighting of assets, as we have debated. In the aftermath of the crisis, regulators introduced the risk weighting of assets as an antidote to the high-risk, high-reward culture pervasive in the banks, but the risk-weighting process has been partial, and it has been self-defined by some of the banks. In the EU, the zero risk weighting attributed to some palpably risky sovereign debts has brought the system into disrepute.

Leverage ratio powers, on the other hand, need to be taken in the Bill and to be phased in ahead of the EU plans for the end of the decade. As I said, that was one of the main conclusions of the Vickers report. Not to legislate for leverage restraint would be a significant omission from the Bill, which the Chancellor, once upon a time, claimed would “reset” the banking system. As Ministers said on the Floor of the House last month, the Government have the power to introduce a leverage ratio in their understanding of the legislation, but that power is ill-defined. It is not clear that section 4 of the Financial Services Act 2012, which amends the Bank of England Act 1998, would ensure that such clear action was possible on a leverage ratio. The new clause would put that legal question beyond doubt.

Most importantly, Sir John Vickers said that a leverage cap of 33 to 1—that is the other way of expressing the leverage ratio of the over-extended nature of some banks— was

“too lax for systemically important banks, since it means that a loss of only 3% of such banks’ assets would wipe out their capital.”

He recommended a sturdier 25 to 1 ratio for systemically important banks—in other words, 4% of equity capital—but the Chancellor has dismissed that particular concern.

It is essential that ring-fenced banks be supported by tougher capital requirements, including a leverage ratio. Determining that leverage ratio is a complex and technical decision that is best informed by the regulator. The Financial Policy Committee cannot be expected to work with one hand tied behind its back, so it is important to put in place the leverage ratio at the earliest opportunity.

The Parliamentary Commission was not convinced by the Government’s decision to reject the Vickers recommendations to limit leverage that way. It stated that it

“considers it essential that the ring-fence should be supported by a higher leverage ratio, and would expect the leverage ratio to be set substantially higher than the 3 per cent minimum required under Basel III. Not to do so would reduce the effectiveness of the leverage ratio as a counter-weight to the weaknesses of risk weighting.”

Sir Mervyn King, the current Governor of the Bank of England, said that the leverage ratio turned out to be

“a far better predictor of the institutions that failed in the crisis”

than measures of risk-weighted assets.

It is not good enough for the Government completely to leave the leverage ratio out of the Bill and to leave the regulators powerless. There are ways to overcome the impact that it would have on a minority of non-plc institutions—I know that some building societies have anxieties about it—and of developing a more sophisticated approach, and the best way would be to involve the regulator. We have suggested doing that in the new clause, which has different minimum leverage ratios for different classes of ring-fenced bodies, and our approach takes account of some of the concerns. In particular, building societies have a different equity structure, but that is no reason for not putting this safeguard in place. We feel strongly about it, as do the various commissions that have spent much time on the issues.

Greg Clark (Conservative, Tunbridge Wells)

The hon. Gentleman began by reflecting that the Bill is just a shell, and that the powers and provisions will be implemented through secondary legislation. Of course, his new clause conforms precisely to that description: all it would do is give a power to set leverage ratios. If he regards that as a problem—most observers seem to think that it is the appropriate structure for a Bill—the new clause does nothing to address it.

The question of leverage is clearly important. It is one of the very few areas on which the Government and the ICB have taken a different view, but there is some common ground. The Basel Committee and the Vickers commission have argued that risk-weighted capital ratios should be the primary capital constraint on banks, and that we should ensure a distinction between relatively safe assets, such as gilts from the UK, and relatively risky assets, such as property investments in some other country.

Jacob Rees-Mogg (Conservative, North East Somerset)

What worries me is that risk-weighting of assets was used before and the wrong risks were given to assets, based on models that were too short-term and did not understand that domestic mortgages could have a high level of risk.

Greg Clark (Conservative, Tunbridge Wells)

My hon. Friend is absolutely right, and I will come on to address the concern embodied in his intervention.

However one defines or looks at them, some assets are palpably more risky than others. Whether in the past authorities had adequate arrangements to assess them, some assets can nevertheless be considered safer than others, which is the point of risk weighting. We must be sure to avoid the adverse consequences of institutions that have relatively low-risk assets on their balance sheet investing their capital in more risky assets but having an identical level of exposure in terms of the leverage ratio.

The primary safeguard—Vickers recommends this—should be through risk-weighted assets. Vickers suggested, through the ICB’s recommendations, that primary loss-absorbing capital should comprise 17% of systemically important ring-fenced banks and CRD IV provides the national flexibility to do that. As members of the Committee know, that dossier has been much debated in recent weeks, but one of the successes of our negotiations so far—scrutiny has not yet been completed in the EU institutions—is establishing the ability to implement the Vickers recommendations in that respect.

In response to the point made by my hon. Friend the Member for North East Somerset that risk weighting needs to reflect actual riskiness rather than a supposed view of the riskiness of assets, CRD III, which was introduced in 2011, significantly increased the risk weights on assets such as complex securitisations in particular to reflect the experience in the crisis that mortgage-based assets proved to be underweighted in terms of their riskiness, which contributed to many of the problems that we have seen.

It continues to be necessary to review that work. The Basel Committee and the European Banking Authority have begun separate reviews of risk weights and risk-weighting methods, with the Basel Committee due to report on those matters in 2014 and the EBA at the end of 2013. The methodology will never be perfect. These are approximations and attempts to glimpse something that is unknowable in an objective sense; it is an assessment made by others on the underlying assets. We are therefore supportive of a maximum leverage ratio for the reasons mentioned by both the hon. Member for Nottingham East and my hon. Friend the Member for North East Somerset. That maximum leverage ratio was, in fact, recommended in Basel III. Through the particular study of the experience of international banks during the last crisis, the Basel Committee established that 3% is the level of leverage ratio that would be consistent with providing the degree of protection that would have been appropriate if it had been applied in anticipation of the previous crisis. That should be implemented through European legislation, and CRD IV provides an ability to do that.

The hon. Member for Nottingham East thought that that should be introduced more quickly, and that has been mentioned by others, but he will be aware that the ICB recommends only that the leverage ratio that it recommends—the high one—should be introduced from 2019; it does not make a recommendation that that should come in earlier. That leads me to note two concerns about the provisions of the new clause. The first is the question of timing.

The new clause seems to propose a provision—the hon. Gentleman confirmed this in his remarks—to introduce the higher leverage ratio now, or at least sooner than would otherwise be the case. Basel III called for mandatory leverage ratios to be introduced, but from 2018. To run ahead of that timetable would certainly create costs, and potentially uncertainty at a time when many of us are trying to encourage banks in the UK to lend more to home buyers and small businesses. Were we to introduce it precipitately, the measure could have material consequences for the real economy at a time when most people in the House would want to see an increase in the lending activity of those banks that we would expect to be ring-fenced.

Secondly, the new clause would imply a higher ratio than is proposed in Basel III. The hon. Gentleman alluded to the expectation, certainly in the building society movement, that the proposal would disproportionately hit institutions that focus on activities that in any reasonable assessment are relatively low risk at the moment, such as the activities practised by building societies. Their concern is that far from being the back-stop that the Government and the Independent Commission prefer, for some institutions it could be a front-stop; it could be the primary constraint. As I mentioned earlier, if those institutions were prevented from practising their current business model, it could drive them into more risky lending.

I am conscious that there is no counsel of perfection in these matters. To refer to what I said on Second Reading, we are seeking to find the best solution to this British dilemma of how we can have a prosperous, functioning, disproportionately important financial services sector, lending to businesses and home owners in this country and trading successfully around the world, while protecting the British economy and particularly the British taxpayer from the consequences and ramifications for the taxpayer and the system that failures would entail. The combination of measures we are taking, in terms of capital requirements and the ring-fencing provisions, leads us to conclude, knowing the particular institutions that we have—I am thinking in particular of building societies—that we are striking the appropriate balance by having exacting domestically specific standards, which are provided for in the European legislation, while taking a broadly international approach. It is worth pointing out that at the moment provision is not envisaged for national differences in the arrangements on leverage, so anything we introduce may have to be rescinded if it were not allowed at European level.

I would like to comment on a few features of the new clause before the debate is opened up. It is not entirely clear from subsection (2) whether the power to be given to the Financial Policy Committee would be a macro-prudential or a micro-prudential one. If it is a macro-prudential use, the Government have made a commitment to give the FPC powers to have a time-varying leverage ratio; that would be introduced in 2018 subject to the review planned at European level in 2017, and we are pressing for the legislation to allow that at European level. In the meantime, of course, the Financial Policy Committee has other tools available, such as imposing sectional capital requirements on areas that it thinks contribute to excessive leverage. If the proposed power is more a question of micro-prudential regulation, the Financial Policy Committee is not the right body with regard to the prudence of particular institutions on their own terms.

The new clause talks about “risk profile;” it would be helpful to understand whether the risk profile of the balance sheet envisaged is a macro-prudential or micro-prudential concern. As I said, if it is macro-prudential, the proposed time-varying power would address that; if it is micro-prudential, it seems to be outwith the remit of the FPC.

Secondly, subsection (2) refers to requiring any

“relevant body to maintain a minimum tier 1 leverage ratio.”

On the face of it, it is not clear to what the “relevant body” refers. Is it intended to be limited to all banks, or is it, as the Independent Commission on Banking recommended, to be applied to a subset of banks, particularly ring-fenced bodies of systemic importance?

We understand that the matter is important. It has exercised both the Commission and the Parliamentary Commission, and I am sure that we will continue to debate it throughout the House. I hope that I have given a reasonable account of the Government’s view as to why the new clause is not necessary and could have consequences, however unintentional, that damage the prosperity of the country.

Jacob Rees-Mogg (Conservative, North East Somerset)

Capital is at the heart of all the financial crises that we have had, and the solution to them. It is relatively simple, and there is a great tendency to over-complicate banking. If bank capital ratios were put right, most of the other problems would fall away. There would be less need to worry about ring-fencing and protecting depositors. Bank capital really is at the absolute heart of what we are trying to do now to put things right. It is worth bearing in mind that the Royal Bank of Scotland had only just over 1% capital; it was more than 90% geared at the point at which the crisis hit.

The question is, what is bank capital all about? It has a number of functions. It is there to absorb losses when banks run into difficulties. If we consider that a reasonably run bank will probably have to write off between 0.5% and 1.5% of its outstanding loans and assets every year, that gives us some idea of the minimum level of capital that is needed. In a bad year, in which the bank loses slightly more than that, it knows the order of magnitude with which it is dealing.

The other reason why bank capital is important is that when depositors turn up at the bank and say they want their money, the bank must be able to provide it; that is the classic run on a bank. The issue that banks have when there is a run is not that they are short of assets but that they are short of liquidity, which is where the definition of assets that are going to be counted towards capital is so crucial. The assets have not only to be of low risk, but to be liquid. When we consider what happened to Northern Rock, there was no shortage of assets, but there was a shortage of liquid assets with which to meet the demands of depositors.

Interestingly, the Bank of England decided not to follow the suggestion of Bagehot that the central bank should be willing to lend when there is a liquidity issue but not when there is a fundamental solvency issue. The Bank of England decided that there was a moral hazard over Northern Rock and that if it came to its rescue, it would leave the wrong impression for all of the banking community. Therefore, the Bank of England decided not to help with the liquidity issue, underlying the point that the capital assets of a bank, the capitalisation ratios, need to be liquid as well as solid assets.

What is it that can be liquid and is a solid asset? They are extraordinarily limited assets. They are the notes and short-dated bonds issued by the currency in which the bank has the majority of its liabilities, or indeed any of its liabilities. If it is a multinational bank, it is conceivable that it will have a run on its deposits in dollars and therefore it will need to have assets in dollars against that. If it is a UK bank, it is simpler just to deal with sterling. It needs to have notes and coins issued by the Bank of England and short-dated Government debt.

Anything that is long-dated immediately loses liquidity. In this context, it is worth bearing in mind what happened to Long-Term Capital Management. LTCM had a simple financial model. It dealt in enormous amounts of money to make a tiny margin on the difference between the benchmark bond and the bond that had just ceased to be the benchmark bond. The bond that has just ceased to be the benchmark bond yields a little more than the benchmark bond, because the benchmark bond has a number of buyers who need it for regulatory or index purposes. It will be in index funds, and so on. Therefore, against the normal trend of the yield curve, the slightly shorter-dated ex-benchmark bond had a slightly higher yield. LTCM piled into those bonds with billions and billons of dollars, and was able to earn a consistent return year in, year out. It was a very successful model, but it catastrophically exploded when liquidity in the ex-benchmark bonds suddenly disappeared. LTCM found that its model no longer worked, and it was left with many billions of dollars exposed in an unwinding market.

Even longer-dated Government bonds, because of the variability and unpredictability of liquidity, are not zero-risk assets. This comes back to the core of the argument: how are assets defined? The hon. Member for Nottingham East said that the Europeans have included some extraordinarily insecure sovereign bonds. Sovereign bonds are not automatically good risk. Anyone who does not believe that just needs to think of the Argentinean bonds that they might have held over the years, or the Chinese bonds that were issued in the 1920s that are used as elegant wallpaper, or imperial Russian bonds, and so on.

It cannot be Government bonds. It cannot be mortgages. Even packaged and resold mortgages ought not to count as the base capital of a bank because of their inherent risk. Again, if there is any doubt about that, look at the ratings given by Standard & Poor’s to packaged mortgages of sub-prime debt. When that debt was packaged together, it gave the highest tiers triple A ratings. What happened to those triple A ratings? They disappeared in a puff of smoke when the underlying mortgages turned out not to be sound. So the ratings agencies cannot be a guide. I have very strong views about the general ability of ratings agencies to predict anything other than what has already happened. It comes back to the simple base capital of short-dated domestic Government bonds, cash and—dare I say it—gold, which always counts as a bank’s capital.

Then the Government need to decide what the right ratio is. My hon. Friend the Member for Wycombe (Steve Baker) thinks it should be 100%. I do not go as far as my hon. Friend, but I think it should be at about the 4% level—higher than is currently suggested by the Bank for International Settlements. We have to be careful about the BIS and Basel, because Basel is deeply political. There was a point when we were arguing at Basel that mortgages should count towards bank capital—this was prior to the Government being in office—because politically that was helpful in this country; it allowed banks to approve more mortgages. As I understand it, the Germans were arguing that loans to small business should count as bank capital because of the structure of German banking. So the BIS and the Basel accords are not independent, Olympian figures that calculate risk outside any political context. They are subject to all the normal political horse trading that international bodies suffer from.

I do not think it will be easy for the Government to get this right, and I certainly want them to take their time. We are emerging from the depths of a crisis, and banks still have many billions of pounds of bad debts on their balance sheets. To tighten bank capital now would be a mistake. It needs to be eased in so that banks can recover and restore their balance sheets first. When it is done, if we want to have a long-term, sustainable banking system, it has to be based on real, solid capital that is liquid and is not dependent on complex financial models, which should be treated with suspicion bordering on contempt.

Greg Clark (Conservative, Tunbridge Wells)

The Committee is grateful to my hon. Friend for his perceptive and elegant summation of the issues that we face. All of us would accept his advice that the science of risk weighting does not merit the name. Even bodies that aspire to augustness, such as the Basel Committee, tend not to be populated by Olympians but by ordinary mortals who are subject to the same frailties as others.

My hon. Friend is absolutely right in reflecting that there should be a separate means of assessing the resilience of the institutions that do not rely on risk rating alone. Whether the appropriate ratio is 3% or higher is a separate question. As he rightly said, the question of when that should apply from is also a separate matter. Our view is that we should have the backstop ratio that is there. We have been persuaded by the Basel agreement. It reflects a study of the consequences of the past few years and the response to the crisis. But the provision that we have in mind is for a variable ratio that is scrutinised and enacted by the FPC and able to respond to the changing conditions. The circumstances in which this leverage ratio would apply will vary. Most people would accept that there are times, such as the time that my hon. Friend alluded to, when people are intoxicated by the availability of credit and the opportunity to make returns from that. That was just the point when a more precautionary approach and a higher leverage ratio should have been instituted.

It is important to have regard not just to a single ratio but to the possibility of a variable one. So the Government’s view that we should introduce in 2018 a power for the FPC to be able to set a variable leverage ratio goes precisely to the point that my hon. Friend was making: that it is in the hands of another group of people—a group of expert people, no doubt subject to the same frailties as the supervisors in the Basel Committee, but nevertheless people charged with having a clear-sighted view on the consequences for financial stability of the way that the system is going from time to time—to look in particular at the leverage ratio and what can be done about it.

My hon. Friend is absolutely right; it is the liquidity, not simply the maintenance of levers of capital, that is important. The Vickers Commission is clear about the importance of that. Paragraph 3.20 of its interim report states:

“In light of the advances made by the FSA and the Bank of England, the Commission will not make recommendations directly on liquidity regulations, but will take due account of them in its work. The reforms contemplated…aim to support the liquidity of banks by ensuring that they remain solvent during times of stress.”

In other words, the provisions for enhanced liquidity—through Basel and other means—are regarded as being complementary to the recommendations.

It is a matter of judgment. It is important that the Committee understands that the Government have no objection whatsoever to a leverage ratio being in place. More than that, we think that the leverage ratio should be an important tool for macro-prudential regulation and that it should be possible to increase it above the 3% level that Basel implies. That should be vested in the way that is proposed in the Financial Policy Committee, so that it strengthens the armoury that that institution has for regulating the sector.

Chris Leslie (Labour, Nottingham East)

I think I heard the Minister say that he supported a leverage ratio that had the potential to go above the Basel minimum recommendation and that may be a slight departure from my understanding of the Treasury’s recommendations hitherto. Setting that to one side, however, I still think that the importance of getting some progress on this issue requires us to address it now in the Bill in some shape or form. I accept the point of phasing in the arrangements and allowing time, particularly in the economic circumstances, to ensure there are no adverse consequences. Nevertheless, over the medium to longer term, putting our banks on a safer and sturdier footing is incredibly important, as all the weight of the evidence of the Vickers Commission and the Parliamentary Commission suggests.

I commend the helpful comments of the hon. Member for North East Somerset. He is insightful about the nature of bank capital and, in particular, issues of liquidity—in general confirming my view that this is not a left versus right wing question. It is not an issue where some on the left think that we need to constrain the banks and others do not. There are some, such as Lord Lawson and others on the Parliamentary Commission, who have taken a very firm view about the need for reform of the structures and the balance sheet arrangements of the banking sector.

The hon. Member for North East Somerset talked about a 4% leverage ratio. That was a really important comment. I understand that in the United States in some circumstances that could be nearly 5%, ironically, although they have the Fannie Mae and Freddie Mac arrangements that tend to distort international comparators of leverage ratio arrangements for some of the banks. Nevertheless, the hon. Gentleman was correct to talk about the need to be wary of going for the lowest common denominator through some of those international institutions, particularly given the importance of the banking sector in the UK economic make-up. It is systemically important for banks in particular, not just worldwide but for our economy, that we apply that extra degree of care and attention to these leverage questions.

Greg Clark (Conservative, Tunbridge Wells)

It is important to put it on the record that the comparison with the US, as the hon. Gentleman implied, is not strictly fairly made, in the sense that there are different elements included and different ratios from place to place. The Governor designate of the Bank of England, when giving evidence to the Parliamentary Commission, said that apples and pears were being compared in those matters. I do not think it right for the Committee to think there is a higher comparable ratio in the US.

Chris Leslie (Labour, Nottingham East)

My point still stands. I certainly agree that, as I was saying, in some ways the level of state intervention in the capitalist entity that is the United States of America is quite high, which ironically makes direct comparisons quite difficult. Nevertheless, I think it is important to recognise that, as the hon. Member for North East Somerset set out, some of the circumstances at RBS and others were quite shocking. We should take the opportunity to learn lessons and ensure that we have put ourselves on the right course.

We have not specified the leverage ratio in new clause 1, because we want it to be variable across different classes of ring-fenced bodies. Systemically important banks are very different from building societies, and that is something on which we ought to take the regulator’s lead. Including new clause 1 would, however, put down an important marker that we consider the leverage ratio to be a crucial component of the safety and security of the banking system. We cannot simply rely on ring-fencing, because this is a bigger story than structural constraints.

For those reasons, rather than simply treating the Committee stage as something that we have to get through and saying that the matter will be dealt with at a later date, we must ask ourselves: if not now, when will we do this? We have to take a stand and sort it out, which is why I would like to put new clause 1 to the vote.