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Banking Bill

The Bill will create major powers for the management of financial instability. However, the powers in the Bill will only be as effective as the system that is to implement them. That is why the current debate on the role of the Financial Stability Committee is so important. If the Financial Stability Committee is to be an efficient means of translating those powers into action, I believe that it must pass three tests. First, it must be consistent with the structure and character of financial services—in particular, with the origins and location of financial instability. Secondly, it must be consistent with the structure of powers as defined in the Bill. Thirdly, it must be constituted in such a way that it will be flexible and responsive to the new problems that will inevitably assail financial services and the British economy in the future. What lies behind those three tests? The first is consistency with the structure and character of financial services. As noble Lords may recall, at Second Reading I argued that in the past three decades the structure of financial services in this country has changed fundamentally and that this change has been an important source of our current woes. The risks to the stability of the financial system are not, as they may have been in the past, located solely in the deposit-taking banks. The disintermediation of the financial system, the creation of long chains of counterparty risk by investment banks and hedge funds and the associated shadow banking system, and the integration of previously distinct markets and institutions into a relatively barrier-free financial system, has extended the potential for financial contagion far beyond deposit-taking banks. After all, in the United States the major institutional failures have occurred outside the banking system—in investment banks, notably Lehman Brothers, and in AIG, an insurance company. If the Financial Stability Committee is to be consistent with the actual structure of the financial services industry today, it must have the information, analysis and stature to measure up to the challenges of a disintermediated financial system. In the current division of regulatory responsibility, the Bank of England has no direct knowledge of the behaviour of firms or the changing structure of markets. That detailed knowledge of markets and firms rests in the Financial Services Authority. The Bank of England simply does not have the detailed supervisory knowledge that it needs to manage financial stability—not just of the banks but of the structure of financial institutions in general. Therefore, by creating the Financial Stability Committee as a sub-committee solely of the Court of the Bank of England as currently proposed, the Bill fails the first test—the test of consistency with the structure of financial services as they really are. Secondly, is the structure of the Financial Stability Committee operationally consistent with the powers in the Bill? During this Committee stage several noble Lords have commented on the awkward dichotomy of powers as between the Financial Services Authority and the Bank of England. The FSA has the trigger power in Clause 7 and the FSA must be consulted at stage after stage. It will be evident from what I have said already that the operations and information systems of the FSA are vital to the coherence of this legislation. If we are to have a distinct FSA and Bank with clearly demarcated responsibilities it is vital for the consistency of the Bill that they are united in the Financial Stability Committee to deal with what must be a joint responsibility. The Bill fails that second test. Thirdly, on flexibility for the future, it must be obvious to all that the structure of the financial services industry must change. It is therefore important that the Financial Stability Committee has the flexibility and breadth of vision, and hence the wide range of experience and opinion needed to deal with these changes. Confining the Financial Stability Committee to the staff and court of the Bank is excessively introverted and restrictive. Thus, the Bill, as drafted, fails the third test. Starting from the position that the proposals, as presented in Clause 228, fail the three tests, I have proposed Amendments 178A, 179A to 179D, 182A, 186A, 186B, 188A, 190A, 192A, 192B, 194A, and consequential Amendment 201A to Clause 239. These amendments will enable the Bill to meet the three tests which I believe the structure of the Financial Stability Committee should meet. The essence of the amendments, which I hope the Minister will accept even if he does not like their particular form, is to make the Financial Stability Committee a joint committee of the court of the Bank and of the board of the Financial Services Authority. This seemingly simple change would transform the role, scope and influence of the Financial Stability Committee for the better. Today the FSA has no direct responsibility for systemic risk. That responsibility rests with the Bank of England but then neither agency has a statutory responsibility for financial stability. The Bill imposes the responsibility for financial stability on the Bank by amending the Bank of England Act 1998. Amendment 201A would perform the same task with respect to the FSA by amending the Financial Services and Markets Act 2000. While a current statutory objective of the FSA is the maintenance of market confidence, it has had, until now, no specific objective of financial stability. It should have such an objective. On the other hand, in the Bill, the management of financial stability becomes a statutory objective of the Bank. However, it does not have the market information to carry out the task it has been given. The FSA has the information, but not the powers, and the Bank has the powers, but not the information. This dangerous dichotomy, already too evident in recent events, can be overcome by making the Financial Stability Committee to be established by Clause 228 a combined committee of the Bank and the FSA jointly and severally responsible for financial stability. This would have the dual advantage of informing the Bank’s stability analysis about the actual operations of firms in disintermediated markets and, at the same time, ensuring that financial stability became a basic tenant of the FSA’s operational philosophy. In other words, the Financial Stability Committee would be an operational bridge between the FSA and the Bank of England, the bridge that has been so conspicuously lacking in recent months. This tackles the first test. The joint committee would also overcome the awkwardness in the allocation of responsibilities in the Bill and answer the question raised by a number of noble Lords about who is in charge. If my amendments are accepted, not only are the respective agencies in charge of areas falling within their particular competence, but they are jointly and severally responsible for financial stability, with that joint responsibility being expressed through the joint Financial Stability Committee. That passes the second test. I now turn to the composition of the Financial Stability Committee proposed in my amendments. I have attempted to keep the committee small, roughly the same size as originally proposed, yet incorporating the key decision-makers in both organisations and retaining the Government’s objective of a significant role for non-executive directors, in this case, of both organisations. The joint chairmen of the committee will be the governor of the Bank and the chairman of the FSA. The two deputy governors of the Bank will be joined by the chief executive of the FSA and one other managing director, probably the managing director responsible for wholesale and institutional markets. There will be a non-executive director from the Bank and one from the FSA. In addition, I propose that there be two independent members appointed by the Treasury. My hope is that they will be informed, sceptical and contrarian. They should not be yet more mutually reinforcing City grandees. Such independent members have been a considerable success on the Monetary Policy Committee, whose collective embarrassments at its actions over the past year would have been all the greater if it had not included that splendid, talented contrarian Professor David Blanchflower, who is sadly leaving the MPC. The possibility of including independent members in addition to the non-execs will greatly increase the flexibility of the committee, and hence the composition of my proposed joint committee passes the third test of flexibility. I hope that the Minister will understand and accept the spirit of these amendments. I will certainly understand if he wishes to modify my proposals on the composition of the committee—it might benefit from a couple more non-execs, for example—but I would find it difficult to believe that he would reject the underlying logic of the proposals, and I am sure that he will want to consider that logic prior to Report.