It is a pleasure to respond to this important debate. First, I should like to correct a grievous omission in my previous remarks. During my paean of praise to the members of the parliamentary commission, I neglected to include my hon. Friend the Member for Wyre Forest (Mark Garnier), who was behind me and therefore was invisible to me. He has been in the Chamber throughout this debate and his contribution is no less sterling and distinguished than those of the other parliamentary commission members whom I did mention. I apologise.
The new clause requires the Treasury to set a leverage target for the
“overall leverage of the…financial system”.
I welcome what I think is the spirit of the new clause. Problems with risk weights clearly contributed to the financial crisis; the right hon. Member for Wolverhampton South East (Mr McFadden) made that point. Those problems must be addressed if risk weights are to have a place in the regulatory regime of the future.
I also share the concerns raised by the parliamentary commission about the importance of having a robust minimum leverage ratio required by the regulator. As my right hon. Friend the Member for Wokingham (Mr Redwood) said, there is clearly support among Members on both sides of the House for that notion. We have consistently argued for a binding minimum leverage ratio to be implemented internationally, to supplement the risk-weighting requirements.
As has been said, the Basel III standard of 3% will come into force in 2018, following an observation period beforehand and a final calibration of the leverage ratio in 2017. Of course, national supervisors must be equipped to respond to new risks as they emerge in banks and financial markets. The PRA, in this country, is empowered to ensure that banks’ risk models are appropriately conservative and, where necessary, to set higher capital requirements.
As every hon. Member will be aware, the PRA has recently announced that major UK banks need to set out and implement plans to improve their leverage ratios and so to migrate further towards the new Basel III standard even now. The FPC has already been given a number of directive powers, including a counter-cyclical
capital buffer and the power to set time-varying sectoral capital requirements. The Government have also made clear their intention to give the FPC the power to vary through time the baseline leverage ratio requirement, always subject to its never being below the requirement determined by Basel III.
Let me address the new clause, in whose support the hon. Member for Nottingham East (Chris Leslie) spoke. The first thing to say is that it requires the Treasury to give the Bank of England a target for the overall leverage of the UK’s financial system; I think I understand the hon. Gentleman correctly when I see an allusion to the inflation target perhaps given to the Bank of England. I have to say, though, that that pulls in the opposite direction to the parliamentary commission’s recommendation, which calls for the FPC—in other words, the Bank of England—to be given the power to determine leverage ratios. In its first and final reports, it noted that
“the leverage ratio is a complex and technical decision best made by the regulator and it certainly should not be made by politicians.”
The new clause cuts across the views of the parliamentary commission, if delivering that recommendation were its intention.
Moreover, the new clause would require a target for the overall leverage of the UK’s financial system. Again, this is not quite the right approach. Banks should certainly be subject to individual leverage requirements to ensure that they have sufficient capital to absorb losses, but an average leverage ratio for the entire financial sector could serve to conceal the risks in particular institutions. It would seem perverse to require the Treasury to set a target for overall leverage and so create an onus on the FPC to allow some banks to remain highly leveraged as long as this is offset by smaller or more conservative institutions running with less leverage. A system-wide average, or net, leverage ratio might be of little value in tackling excesses of leverage, and it could be positively counter-productive.
Another feature of the new clause would be dangerous. The proposal for a target requires the FPC to pursue action to meet the target. It is suggested that the FPC take action to increase leverage in the system when it is less than the target level that the Government are required to set. I am not clear how or why the FPC would want to do that. The target approach seems to me to be wrong. Financial stability is not like price stability; it cannot be boiled down to a single, symmetrical target. As a recent Bank of England paper concluded:
“No single set of indicators can ever provide a perfect guide to systemic risks, or to the appropriate policy responses…Judgement will, therefore, play a material role in all FPC decisions and policy will not be mechanically tied to any specific set of indicators.”
We need to apply caution in any consideration of enshrining in law a system that focuses on one target for systematic financial stability. Goodhart’s law is relevant in these circumstances:
“When a measure becomes a target, it ceases to be a good measure.”
I therefore hope that on reflection the hon. Gentleman will withdraw his new clause.