My Lords, this Bill legislates for ring-fencing. That is the Government’s policy, not Glass-Steagall-style full separation. The Government support ring-fencing, but not as a compromise option or a lukewarm version of separation, and not as a watered-down policy. Rather, the Government have adopted the ring-fence after careful consideration of the recommendations of the Independent Commission on Banking. As noble Lords will recall, the ICB was established in June 2010. It deliberated for 15 months before making its recommendations in September 2011. As part of its deliberations, the ICB considered full separation as an alternative to ring-fencing, but it rejected that alternative and instead recommended ring-fencing. The Government have accepted the ICB’s recommendation, and the commission set out its rationale for rejecting full separation in its final report.
Let me remind the House of the ICB’s line of reasoning. The ICB argued that an effective, robust ring-fence would deliver the same benefits to financial stability as full separation, on the model of Glass-Steagall. A robust ring-fence will insulate vital retail banking services from shocks to global financial markets—for example, reducing the risk that British high-street banks will be brought down by swings in the prices of complex securities. Let us recall, too, that retail banking has its risks and that market discipline demands that badly run banks must be allowed to fail. If a retail bank fails, a robust ring-fence will enable the authorities to manage that failure in a controlled way, with essential services kept running with the core deposits we were talking about, but without any injection of taxpayers’
money. So, a strong ring-fence will minimise the chance that a future Government will ever be forced to bail out a failing bank. The moral hazard that encouraged excessive risk-taking before the recent crisis would be removed.
The ICB argued that a robust ring-fence would deliver the same benefits as full separation, and would avoid some of full separation’s main disadvantages. In particular, a ring-fenced bank that found itself in financial difficulties could be supported by other group members, such as a healthy sister investment bank. Full separation would not allow this. Essentially the ring-fence is a valve; it does not let any of the bad stuff get into the ring-fence but allows support to come in if it needs it.
Under ring-fencing, a banking group could offer a one-stop-shop service to customers, especially business customers, so there is a strong marketing advantage to the group. Deposits or simple loans could be arranged with the group’s ring-fenced bank, while more complex products are supplied by the group’s investment bank. Full separation would not allow this. Finally, the ICB estimated that by denying banks the legitimate benefits of diversification, full separation would impose higher costs—costs that would likely be passed on to banks’ customers and to lending.
In summary, ring-fencing will bring the same benefits as full separation, but with fewer disadvantages. A rational, sober evaluation of the two thus brought the ICB to identify ring-fencing as the superior policy. I would like to use this opportunity to put paid to some myths around ring-fencing versus full separation. First, some claim that full separation is simpler to legislate for, and there is no complexity. Any separation of banks’ business will inevitably involve detailed rules to specify where the line, whether it is a ring-fence or a complete separation, is to be drawn, and proscribe which activities must take place either side of that line. As banks’ business is complex and involves a wide range of different products and services, so drawing that line will inevitably be complex. But a line will have to be drawn and someone will have to decide what is in each separated type of bank. It is the same problem for ring-fencing and full separation.
Secondly, either form of separation will, unless vigilantly maintained, be vulnerable to erosion or bank lobbying. There are plenty of examples of that through history. I do not, therefore, accept that full separation is either more simple or more robust than ring-fencing. As I have already said, the ICB conducted an exhaustive and detailed investigation of the case for different types of structural reform before coming to its recommendation in favour of ring-fencing. That recommendation commanded a wide consensus—including regulators, industry and the Opposition. Let me quote the shadow Chancellor speaking in the Commons when the Government first responded to the ICB in December 2011. He said that,
“we, too, support the commission’s radical reforms on ring-fencing”.—[Official Report, Commons, 19/12/11; col. 1074.]
Of course, no matter what the weight of evidence, there will always be some who disagree with the consensus. But to those who advocate full separation as an alternative, we need to ask: what is the evidence that supports this
alternative policy? Throughout this process so far, the Government have openly invited others to give their views and present new evidence. We consulted widely, and submitted this Bill to pre-legislative scrutiny by the PCBS to seek its input. I do not think that the PCBS produced hard evidence in favour of full separation. It presented nothing that compared the two proposals, although it elicited some strong expressions of scepticism on whether it would work. Those are valid. It is certainly a new way of doing things.
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Where reasonable, the Government have accepted changes to the Bill that would address these concerns about the efficacy of ring-fencing. For example, Andrew Bailey, head of the PRA, argued for greater clarity over the regulator’s objectives. Similarly, Andy Haldane of the Bank of England told the PCBS that:
“The following ingredients are essential if this ring fence is not to prove permeable: ... separate governance ... separate risk management ... separate balance sheet management, treasury management ... separate remuneration structure ... separate human resourcing”.
So the Government clarified the regulator’s objectives, and have specified the parameters for the regulators’ rule-making, placing the Haldane principles in the Bill. We have thus made the changes that the regulators—the experts who will police the ring-fence—said were needed to make the ring-fence work. We have also taken on other reasonable suggestions made by the PCBS and others to make the ring-fence more robust. For example, we have accepted the PCBS’s proposal to electrify the ring-fence by giving the regulator power to separate a banking group that fails to uphold the ring-fence. We have agreed to use the affirmative resolution procedure to deal with changes in secondary legislation to the ring-fence.
Responding constructively to suggestions from all sides, we have thus addressed concerns over the robustness of the ring-fence—the sole argument that has so far been advanced against it. The regulators are now content that the ring-fence can be made to work. As it is they, not Parliament, who will police the ring-fence, we must take their views seriously.
Some members of the PCBS may shortly argue that a further reinforcement of the ring-fence is required, in the form of full separation framed as a deterrent—not to be implemented immediately, as in this amendment, but triggered following a future review. They will argue that this is a much more reasonable position than that taken by the noble Lords, Lord Barnett and Lord Peston. As I will explain, the Government do not accept that a provision for full separation can act in support of the ring-fence as a deterrent. Rather, it is a different policy, where a reserve provision is an inappropriate way to legislate. It is at best unhelpful, at worst bad law-making.
I am very grateful to the noble Lords, Lord Barnett and Lord Peston, for calling a spade a spade, and acknowledging in this amendment that full separation is an alternative policy to ring-fencing, not a complement. To take that alternative would be to abandon the ring-fence. It would be contrary to the weight of evidence and analysis assembled by the ICB, without being grounded in a robust evidence base of its own.
It would be a policy based purely on assertion and scepticism. The Government cannot accept that, so I call on the noble Lord to withdraw his amendment.