Banking (No. 2) Bill [HL]

My Lords, it is a daunting task to follow such a distinguished economist as the noble Lord, Lord Peston, in this debate, particularly when I find myself in the unusual position of agreeing with much of what he said. I should like to draw attention to my various interests relating to the Bill, and emphasise that I speak here in a purely personal capacity. Although there are some detailed questions on the Bill that will come out in Committee, and one or two that I should like to raise today, like others, I recognise the need for the measures in the Bill. However, my primary question, like that of every noble Lord who has preceded me, is whether those measures are enough or whether we should be taking advantage of the legislation to provide a more complete response. The advantage of speaking at this stage in the debate is that I can put my arguments in the context of those which have been made before. The Bill is about restructuring and recapitalising banks that are judged to be no longer capable of standing alone without significant risk to the financial system. The first thing to recognise is that restoring capital levels to replace the losses suffered from bad assets is of itself not enough to restore lending to pre-2008 levels. The recent Bank of England financial stability report showed that the leverage ratios of major banks had risen steadily over recent years to reach a median level of 35 times equity capital, with the top interquartile range doubling over the past 10 years from around 25 times equity levels to close to 50 times equity levels. The Bank of England does not do the arithmetic to provide estimates of the average leverage ratio of the banking system, but I think that we can take it from these figures that it has also risen significantly. This is just the flipside of the coin of the growth in consumer and business indebtedness over the period. Household borrowing has risen over the same period from 60 per cent to 90 per cent of GDP, and bank lending to non-financial companies is also up a third over the past 10 years from just over 20 per cent to around 35 per cent of GDP. This has been accompanied by a simultaneous increase in government borrowing, which is well over 50 per cent of GDP on any measure. If we are to bring bank gearing levels and their counterpart in consumer and business borrowing levels back to more sustainable levels, and if we are to close the macro-funding gap between domestic saving and domestic borrowing, about which the Bank of England is concerned, the consequence, notwithstanding the views of the noble Lord, Lord Barnett, must, in the short term, be a severe and painful contraction in the total volume of bank lending. It would be helpful if the Minister would accept on behalf of the Government that, notwithstanding exhortations to lend, a major reduction in bank lending is inevitable until bank gearing levels are reduced. This is the degearing effect, about which we hear so much. Can the Government guide us on what level of degearing they expect, over what timescale, and what impact they believe it will have on total lending volumes and nominal GDP? However, this is not the whole story. Some 35 years ago, I confess that I wrote a rather unexciting doctoral thesis that predicted that in such periods of credit tightening, banks would end up rationing credit to small business customers because the price mechanism would not adjust lending volume quickly enough to restore balance sheet equilibrium and meet regulatory ratios. Although that thesis has gathered much dust over the years, I fear that we are in just such a situation now. The banks which have been wholly or partly nationalised, as the noble Lord, Lord Barnett, described, are no less immune to that problem despite their greater access to secure capital. Bank managers are simply saying no, because they have no other way of trimming back their balance sheets in the time available. The Bill will not fix that problem. The second and, perhaps, greater short-term problem is, as others have said, that of liquidity. As we know, the shortage of liquidity is not necessarily directly related to capital levels. As the Minister agreed yesterday in the debate on statutory instruments, Bradford & Bingley was judged incapable of standing alone because of its concerns about liquidity, despite having a tier 1 capital ratio of close to 10 per cent. Underlying the shortage of liquidity is the continued unwillingness of banks to lend their surplus liquidity in the wholesale market for fear that when they need the liquidity back it will simply not be available. This, too, is adding to the pressures on banks to rein back their lending and this, too, will not necessarily be fixed by the measures in the Bill. I accept that, as the Minister said, the Government and the Bank of England have taken steps to address the liquidity issues through purchasing qualifying assets by the Bank of England, selling insurance to guarantee wholesale lending and other measures. Although these schemes have undoubtedly helped, they clearly have not yet solved the liquidity problem, as evidenced by the continued shortage of wholesale money and the continued high cost of interbank funds. Part of the reason is that the costs that the Government and the Bank of England have imposed in these schemes, which seek to penalise banks for their past behaviour, make it less attractive to mobilise funds for the future. What do we do about this? One response posed by the opposition Front Bench is to guarantee lending to small businesses; that may be part of the solution. Another possibility, mentioned by the noble Lord, Lord Newby, and which should be explored, is to allow regulatory ratios to be relaxed at the trough of the cycle so that we do not expect banks that have just been hit by the equivalent of a one in 200-year exceptional loss immediately to rebuild their balance sheets to the point where they can withstand an equally severe loss happening again immediately. I wonder whether, in this exceptional situation, as described by my noble friend Lord Saatchi, there is a case for going back to first principles and rethinking more fundamentally what banks are and how they should be structured and regulated. The definition of a bank, set out in Clause 2 of the Bill, is fairly conventional. The truth is that as every economics course teaches, banks are indeed unique and special in their ability to manufacture money supply, where every loan also becomes a new bank liability and where, ever since we moved away from gold specie, bank deposits have counted as a reliable and trusted part of our currency. As the noble Lord, Lord Smith of Kelvin, and my noble friend Lord Saatchi said, the underlying dilemma we have with the current situation is that banks have taken low risk deposits from customers—deposits viewed by those customers as a trusted part of the money supply—and used them at the edges of their balance sheets to take on highly risky and highly leveraged investments. When those risks come home to roost, as every so often they will, we are faced with the problem we now have of propping up the banks or allowing a collapse in confidence in the money supply. Clearly, a collapse in confidence in the money supply is something which the Government cannot allow. This is not like some other utility. Confidence in the money supply and the currency constitutes the central essence of confidence on which the whole economic system rests. I propose a possible solution to the problem posed by my noble friend Lord Saatchi. Perhaps we should think radically, call a spade a spade and simply say that all deposits in regulated banks are de facto part of government guaranteed money supply in which consumers, businesses and, indeed, other bank counterparties can have total confidence. The corollary is that institutions which call themselves banks and fall under this protective umbrella would have to meet very tight prudential regulatory requirements. In particular, they would have to limit themselves to low risk conventional loans and investments, something akin to the assets that most depositors have in fact assumed their banks would hold in order to protect their cash deposits. That would not, of course, prevent other financial institutions, or indeed other parts of the same institutions, accepting funds for investment and investing those in more risky assets. However, they would be clearly segregated from those institutions which were known as banks, their investors would be on notice that the higher returns they were offered were in exchange for a higher risk and the security of the money supply would be maintained. My problem with this Bill, therefore, is not that what it proposes is not sensible or necessary given the circumstances we face, but that ultimately it may be inadequate because it is based on perpetuating an unstable banking structure that links government-guaranteed money supply and risky market investment activities within the same legal and financial structures. As my noble friend Lord Saatchi said, this problem has been made far greater than ever before by the multiplication of financial instruments that have allowed banks to extend into areas of risk and investment that were never available in the past. The next few months will show whether my fears on continued liquidity shortages are grounded. It may be—and I am sure we all hope that this will be the case—that things will return to some kind of normality. Things may ease after the year end, once banks have got through reporting their year-end balance sheets. However, if we are to provide the confidence necessary to fix the liquidity problem in the future against the new background of financial instruments with which we are confronted, we may have to face the need to underwrite all deposits, including wholesale deposits, at regulated banks. If the Government underwrite all deposits, we will need to change the definition of banks in the way I have suggested so that the powers created in this Bill do not have to be used over and over again every time we have a future credit cycle. For that reason, while I do not oppose the Bill, I hope that it can be part of a wider debate which addresses some of the more fundamental questions I have raised. In the mean time, I should like to raise three specific questions on the Bill as it stands. First, I note that in the appropriately numbered Clause 4, setting out the objectives that will guide a special resolution, subsection (9) states that all the objectives are to be balanced in each case. I wonder whether that is sufficient, or whether subsection (8), which requires action not to interfere with property rights in contravention of the Human Rights Act, must not ultimately take precedence; or, to put it another way, that any action taken must be compatible with the fair treatment of property rights to which the Minister signed up yesterday in the discussion on statutory instruments. Secondly, in the same list of objectives I notice that there is no mention of the desirability of maintaining open, competitive markets. I should welcome assurance from the Minister that the Government's support for competition, and the benefits of innovation, productivity and consumer value that competition brings, will not be diminished in the current economic conditions. I should like the Government to consider whether that objective should properly be reflected in Clause 4. While the Bill, as I understand it, does not explicitly deal with arrangements for the government holding company, UKFI, as the noble Lord, Lord Newby, mentioned, I assume that the provisions apply to partial nationalisation as well as full nationalisation. Where the Government are only a partial owner of a bank, can the Minister explain whether government directors and the UKFI itself will be subject to the normal market rules that apply to large shareholders and the proceedings in relation to the companies in which they hold shares, and that adequate board procedures will be required of those companies to allow the remaining independent directors to safeguard the interests of minority shareholders? I look forward to Committee stage.