My Lords, I am sure that all noble Lords will be pleased to see the noble Baroness, Lady Penn, in her place today. I enjoyed working with her on the passage of the Financial Services and Markets Act in the last Parliament, when I was new in my role and she knew a great deal more about the Act than I did. Now I am new in my role again, and I am quite sure she still knows a great deal more about this Bill than I do; I am sure that I will enjoy working with her just as much. I am also pleased to see and work again with the noble Baroness, Lady Kramer, who probably knows more about this subject than the rest of us put together.
The Bank Resolution (Recapitalisation) Bill will enhance the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of banks. It ensures that, where failing banking institutions require intervention, in particular smaller banks, certain costs of managing their failure do not fall on taxpayers. It strengthens protections for public funds and promotes financial stability, while supporting economic growth and competitiveness by avoiding new upfront costs on the banking sector.
The resolution regime was introduced in the wake of the global financial crisis and implemented in the UK through the Banking Act 2009. It provides a number of additional tools to the Bank of England to manage the failure of financial institutions safely, helping to limit risks to financial stability, public funds and the economy. The regime was introduced in recognition of a global consensus that reforms were needed to end “too big to fail” and ensure financial institutions could wind up their operations in an orderly way. This regime has been developed and added to steadily over the past decade by a succession of Governments, giving the UK a robust regime and supporting its role as a leader in financial regulation, while also reflecting relevant international standards.
The regime was last used to resolve Silicon Valley Bank UK, the UK subsidiary of the US firm that collapsed in March 2023. The Bank of England used its powers under the Banking Act to facilitate the sale of Silicon Valley Bank UK to HSBC, delivering good outcomes for financial stability, customers and taxpayers. All the bank’s customers were able to continue accessing their bank accounts and other facilities, and all deposits remained safe, secure and accessible. In doing so, the Bank of England ensured the continuity of banking services and maintained public confidence in the stability of the UK financial system.
While the case of Silicon Valley Bank UK demonstrated the effectiveness and robustness of the resolution regime, the Bank of England, the Treasury and international counterparts have carefully considered the implications of this wider period of banking sector volatility. This builds on the proposals set out in consultation by the previous Government, following the work they did with the Bank of England after the Silicon Valley Bank case. This Government believe there is a case for a targeted enhancement to give the Bank of England greater flexibility to manage the failure of small banks effectively. I hope that, given the origin of these proposals, they will be welcomed by noble Lords from across the Chamber.
My Lords, I welcome the noble Lord to his place on the Front Bench. In reviewing the short list of speakers in this Second Reading debate, I am very conscious that I probably know less about this topic than anybody else who is about to speak. So, I feel peculiarly exposed, coming immediately after the Minister and giving the opportunity to all subsequent speakers to point out where I have got things wrong. None the less, that is the luck of the draw. I will say at the outset that I do not object to the measure proposed in this Bill. What I want to raise is the question of whether we have quite the robust bank rescue system that the Minister thinks we have and said we have during his introductory speech.
Silicon Valley Bank is the starting point of this. In some ways, Silicon Valley Bank was not a bank failure; the parent bank failed in America but the UK subsidiary did not in itself fail, and was successfully sold to the private sector. It was sold, admittedly, for a nominal sum, and the shareholders lost their money, but none the less that is a good outcome, and those involved are to be congratulated on succeeding in doing that. The bank continues to operate and it is there in the private sector; no taxpayer money was thrown at it, and that was a successful outcome.
The Bill arises, therefore, not so much from Silicon Valley Bank as from officials thinking about what might have happened if it had all gone wrong and whether we would have needed an additional power had it worked out rather differently. That line of thinking is also to be welcomed; it is good that officials think about what might have happened if things had gone wrong, and whether they would need an additional power. So we might reach the conclusion that we have a very robust system, but what I am saying is that it was not really tested very well.
It is worth examining the players in this system, and how bureaucratic and inflexible the system has become as we have set it up. The responsibility for sorting out a bank failure rests with the resolution authority, which is a department of the Bank of England. Should it have to acquire ownership of a bank in the course of a rescue, the bank would become a subsidiary of the Bank of England, and as long as that continued it would be, in a sense, as safe as the Bank of England, as we used to say. However, further down the corridor is another department of the Bank of England, called the Prudential Regulation Authority, and it would not be having any of that at all. The Prudential Regulation Authority would say, “It may be a subsidiary of the Bank of England, just as we and you are a department of the Bank of England, but we are going to insist that it is separately capitalised”. Indeed, the Bill is addressed at finding a route and an additional tool whereby that capitalisation could be provided. So we have two departments here that are not entirely working together, and are treating each other as alien bodies. That is rather distressing.
My Lords, I welcome the Bill, as I do the recognition that resolution, rather than insolvency, can be a better public interest solution for smaller banks, or at least for some smaller banks. Smaller and specialist banks are providing banking services, in particular to growth companies and start-ups, which cannot easily get banked with big banks. Likewise, I continue to hope that we will have community banks. I believe that the resolution process, should it come to that, looks a more supportive outcome all round.
As Silicon Valley Bank showed, businesses have a harder time protecting their deposits when there is a need to have sizeable sums available for running the business, including paying salaries, and that resolution reaches a fairer solution for businesses and their employees. It is a pity that it is always a megabank that has to come to the rescue, but it has ever been so, and of course again they get more competitive. We had concerns at the time, which the Minister has already covered to some extent, that maybe the HSBC ring-fence was got around; my noble friend Lady Kramer may mention that as well.
Overall, though, I have no concerns about the principle and content of the Bill, but there are a few related points that I would like to raise. The cost-benefit analysis shows that resolution can be less expensive—in effect, just using funds that would have been paid out to insured depositors. I would say that even if it were a bit more costly, it has a public interest benefit.
I also wonder whether there can be double or hybrid dipping into the FSCS; for example, if the resolution included a haircut on deposits, bringing deposits under the £85,000 level and triggering individual payments so that there could be both recapitalisation and individual compensation drawn from the FSCS. These might seem strange proposals, but I saw some very strange proposals during the financial crisis in the EU. Double dipping for recapitalisation, or subsequent rounds of recapitalisation, is envisaged in Clause 2—or is it the case that loss of deposits will be done only as part of insolvency? Is there a bar to mixing the two?
My Lords, I declare my interest as chairman of C Hoare & Co, which would almost certainly be classified as a small bank for the purposes of the Bill.
I congratulate the Minister on becoming Financial Secretary to the Treasury. After the chancellorship of the Exchequer this is the oldest Treasury ministerial post, and I am pretty sure that it is the first time that it has been held by a Member of this House. I had the good fortune of working with the Minister for a decade around the turn of the century. He has huge Treasury experience and considerable ability and was a pleasure to work with. I wish him well in what will inevitably be difficult times ahead when no doubt he will come to this House on many occasions to make Ministerial Statements.
I speak in support of the Bill, which is a model of good legislative practice with a well-handled consultation and cross-party support. It is welcome that the new Government have seamlessly picked up where the previous Government left off. Politics is all about difference, but at least 90% of governing is about continuity.
Having been the Permanent Secretary and accounting officer when the Treasury had to nationalise Northern Rock and resolve the Icelandic banks in 2008, I am acutely aware that having the necessary powers in place makes it a whole lot easier. Of course, the Government can generally rely on common-law powers in such circumstances or, in the case of Northern Rock, pass an emergency Bill in 24 hours. I pay tribute to the late Lord Darling for managing the financial crisis so effectively with the limited powers then at his disposal, but I would not recommend a make-do-and-mend approach; it diverts finite resources from the job in hand, which is managing the crisis itself. It is better to have the right legislative and institutional framework in place, and to learn from each time the framework is tested in order to improve its functioning.
My Lords, the introduction of the resolution regime in the Banking Act 2009, and the subsequent development of living wills in which large banks are required to produce plans for how they could be wound up, are both designed to reduce the risk of the cost of failing banks falling on the taxpayer. This Bill seeks to add an additional protection for the taxpayer, by shifting the risk of funding the resolution of a bank from the Treasury to the Financial Services Compensation Scheme and therefore to the banking sector as a whole in subsequent levies—so far, so good. The Explanatory Notes provided by the Treasury suggest that the purpose of this legislation is to provide for the resolution of small banks, citing the resolution of Silicon Valley Bank UK as an example of where the successful resolution of a failing bank was clearly preferable to the alternative—namely, insolvency.
Maintaining the operations of a bank, particularly where the asset side of the balance sheet is strong, if illiquid, has obvious advantages. It avoids the disruption of banking services that occurs under formal insolvency procedures. Indeed, the sale of Silicon Valley Bank UK to HBSC for £1—I wonder if anyone knows whether that was actually paid; perhaps the noble Baroness, Lady Penn, knows—ensured that banking services were maintained by HSBC for an important segment of UK industry.
The focus on small banks is important. It is a recognition of the important role—referred to just now by the noble Baroness, Lady Bowles, yet so often unrecognised—that small banks are playing in the UK economy today. I will give the House just one example: a bank called Unity Trust Bank. It has a balance sheet of a little over £1 billion. To give an idea of scale, the balance sheet of Barclays Bank is 1,500 times larger. Last year, 87% of Unity’s quarter of a billion in new lending supported projects in health and well-being, community spaces and services, education, skills and employment, and financial inclusion. Around half of that lending went to parts of Britain defined as areas of high deprivation, as measured by the Index of Multiple Deprivation. It achieved all this while earning a very healthy return on equity and maintaining a tier 1 capital ratio of 20%. If Barclays’ numbers were the same as that, Britain would be a very different and a very much better place. This is just one example of the excellent work done by small and medium-sized banks.
My Lords, it is always a pleasure to follow the noble Lord, Lord Eatwell, with his in-depth analysis and huge knowledge of this area. I feel I will probably fall short after that, but I will give it my best go.
This Bill provides the Bank of England with slightly greater flexibility to find a resolution to a bank failure other than insolvency, at a cost to the rest of the banking industry. As we have heard, it follows on from the lessons learned from the insolvency of Silicon Valley Bank. As such, I think that, like everybody else, I am generally supportive of it. But it does beg some questions, so, rather than making points about its merits or demerits, I will ask the Minister a number of questions about how it will operate in practice and some of the potential impacts.
First, the Special Resolution Regime effectively splits the banking industry into two tiers: those larger banks whose failure might create systemic risk, which are required to maintain excess debt and equity over the minimum capital requirements, known as MREL, and smaller banks whose failure would not be expected to create systemic risk, which do not hold MREL. SVB was a small bank whose failure was none the less considered to create some systemic risk because of the nature and concentration of its customer base. The Bank of England therefore decided to follow a resolution procedure, which it felt was better than allowing SVB to go into insolvency, which would have restricted its customers’ access to their funds, which I think the noble Lord, Lord Moylan, referred to. SVB was then rapidly transferred to HSBC for £1—a good result all round, I think. Customers retained continuity of access to funds and did not lose any of their deposits and HSBC gained a subsidiary that it said would accelerate its strategic plan by two or three years.
However, this begs the question as to whether we have the classification right for which banks are required to hold MREL. It is currently based primarily on size. Should the PRA be required to do more to ensure systemic risk has been identified before failure? SVB seems to have come as something of a surprise, and its risk profile does not seem to have been recognised in advance, so it appears to me that the current classification should be reviewed and that we should at least consider extending the MREL regime to small banks whose failure would none the less create some systemic risk. I would welcome the Minister’s thoughts on that.
My Lords, when you are the last speaker in the queue, you find that all the good points have already been made and you have to rewrite your speech rapidly. I have a number of questions for the Minister. First, this Bill suspends the iron law of capitalism, which is that the inefficient and incompetent go to the wall. Somehow that is not to be applied to the banking sector. If the Minister considers the provisions of the Bill to be good enough for a flourishing finance industry, why not apply them to other sectors where we have many essential businesses?
Looking at the Bill, it seems to assume that the Financial Services Compensation Scheme—the FSCS— has significant reserves from which the Bank of England could immediately obtain benefits. Will the Minister explain what kind of reserves the FSCS is required to maintain and how their adequacy is judged? Its accounts for the year to 31 March 2023 show it had a surplus of just £5 million, which was then taken to cover the deficit of the pension scheme. In other words, there was a zero surplus for that year, but the cumulative cash balances were £510 million. Is that enough to rescue one or more banks or do these buffers need to be beefed up? I hope the Minister will be able to tell.
Bank failures could be localised or they could have a domino effect, in which case the FSCS would not have adequate resources. Will the Minister explain what would happen then? As I understand the Bill, insolvency would be the only option left. What have we learned about the insolvency of banks? The biggest insolvency was in July 1991 when the Bank of Credit and Commerce International was shut down, but to this day there has been no investigation, no report, nothing. What have we learned about insolvency of banks? Would the Minister like to reopen that probe and tell us why there has been no investigation, why there has been a complete cover-up and what we could have learned from it to devise better regulations?
My Lords, as the first of the winding speakers, I can repeat all the good points. This has been an exceptionally strong debate. I have welcomed the Minister on previous occasions and I welcome him again to his role. I can very much support this piece of legislation, picking up on the points made by the noble Lord, Lord Macpherson. It seems to me to be one of the first sensible approaches to dealing with the failure of small banks and, I hope, minimising the exposure of the taxpayer. However, I very much pick up the points made by the noble Lord, Lord Eatwell. If this happens on a mass or systemic basis, essentially the taxpayer is always going to be the body in play, and we should not fool ourselves that, in a really mass crisis, the banking sector as a whole will be able to pick up the problems of a large part of banking in the UK. We have to be realistic on this issue.
In fact, I have always thought that it was pretty unrealistic that most small banks could be allowed to fail, with depositors protected only up to £85,000 by the Financial Services Compensation Scheme. Therein lies the potential for a sudden run on many other banks, with flight based on rumour and social media. I suspect that, if the Government or the regulators attempt to allow failure to be a significant part of the programme for dealing with problematic banks, they are going to find once again that they are facing the impossible. Sometimes, we have to be realistic. Often, schemes which look good on paper just do not work out in the practices of real life.
The Treasury and the regulator found this out the hard way when Silicon Valley Bank UK effectively failed thanks to the troubles of its US parent. As others, including the noble Lords, Lord Vaux and Lord Eatwell, have said, SVB had to be saved through its forced sale to HSBC for £1. Perhaps this new, more realistic process could be done with an individual bank. Is that unrealistic? Can the Minister elaborate on this? Could we not just be much more open and say that we are looking for resolution? Failure would then come only in the most extreme and rare of circumstances. Picking up on the point made by my noble friend Lady Bowles, resolution is the path to go down if we are to have a banking system in which the general public at large continue to have real trust.
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It is worth noting that small banks that fail are typically expected to be placed into insolvency under the bank insolvency procedure and are currently not expected to meet the conditions that must be satisfied for the Bank of England’s resolution powers to be used. These conditions include whether exercise of the powers is necessary to meet certain objectives of resolving a bank and is in the public interest.
Under the bank insolvency procedure, upon entering insolvency, the Financial Services Compensation Scheme compensates eligible depositors for account balances up to £85,000 per depositor within seven days, with higher limits for temporary high balances. This compensation is funded initially through a levy on industry and then, where possible, recovered from the estate of the failed firm.
Following the case of Silicon Valley Bank UK, the Government’s view is that in some cases of small bank failure, the public interest and resolution objectives may be better served by the use of resolution powers than insolvency. If, in future, a failing small bank were to require resolution, it may require additional capital. This may be needed for a range of reasons: for example, to meet minimum capital requirements for authorisation or to sustain market confidence. At present, these costs may initially have to be borne by taxpayers, as the Treasury would be the only available source of funds to meet these expenses. That is an undesirable status quo.
A key aim of the Bank Resolution (Recapitalisation) Bill, therefore, is to strengthen the protections for public funds where a small bank is placed into resolution instead of insolvency. Overall, this is a necessary and, I hope, uncontroversial set of reforms in order to ensure the regime effectively continues to limit risks to financial stability and to taxpayers.
It is important to note that the bank insolvency procedure will still have an important role in managing the failure of small banks. Relatedly, the Government do not intend to make widespread changes to a resolution regime that is already working well. Instead, this Bill reflects the view that there is merit in a targeted set of changes which ensure that, if needed, certain existing resolution tools can be applied to small banks in a way that achieves good outcomes for financial stability while also protecting taxpayers.
The Bill achieves this by introducing a new mechanism. This mechanism allows the Bank of England to use funds provided by the banking sector to cover certain costs associated with resolving a failing banking institution and achieving its sale, in whole or in part. The Bill does three things to create the new mechanism. First, it expands the statutory functions of the Financial Services Compensation Scheme, which will be required to provide funds to the Bank of England upon request, to be used where necessary to support the resolution of a failing bank.
Secondly, the Bill allows the Financial Services Compensation Scheme to recover the funds provided by charging levies on the banking sector. This is similar to the current arrangements for funding depositor payouts in insolvency, with the exception of the treatment of credit unions. In response to feedback from industry, the Government have decided to carve out credit unions from levy contributions in recognition of the fact that they cannot be put into resolution, and so the new mechanism cannot be used on them. It is important to note that this means the banking sector is levied only after the event of failure, not before, thereby avoiding new upfront costs on the sector.
Thirdly, the Bill gives the Bank of England an express ability to require a bank in resolution to issue new shares, facilitating the use of industry funds to meet a failing bank’s recapitalisation costs. Taken together, these measures give the Bank of England a more flexible toolkit to respond to small bank failures in a way that promotes financial and economic stability. Critically, they strengthen protections for taxpayers’ money, while avoiding new upfront costs on the banking sector.
The Bill consists of five clauses and is narrow in scope. I will now set out how each of them operates and the effect they produce. The first clause inserts into the Financial Services and Markets Act 2000 a new section which introduces the new mechanism. It allows the Bank of England to require the Financial Services Compensation Scheme to provide the Bank of England with funds when using its resolution powers to transfer a failing firm to a private sector purchaser or bridge bank. It sets out what these funds can be used for: namely, to cover the costs of recapitalising the firm and the expenses of the Bank of England and others in taking the resolution action. It also allows the Financial Services Compensation Scheme to recover the funds provided through levies.
The second clause sets out that the Bank of England must reimburse the Financial Services Compensation Scheme for any funds it provides that were not needed. The third clause primarily ensures that existing provisions relating to the Financial Services Compensation Scheme apply to the new mechanism in the same way. The most substantive change specifies that the Financial Services Compensation Scheme cannot levy credit unions to recoup funds provided under this mechanism. The most substantive change in the fourth clause gives the Bank of England the power to require a failing firm to issue new shares. This will make it easier for the Bank of England to use the funds provided by the Financial Services Compensation Scheme to recapitalise the firm by using the funds to buy the new shares. The fourth clause also makes several consequential changes to reflect the introduction of the new mechanism. The fifth and final clause sets out procedural matters, including that the Treasury may make regulations to commence the provisions in the Bill.
The key proposals in this Bill have been subject to consultation with industry, and the Government appreciate the feedback they have received and have reflected on it carefully. The Government note the concerns about the appropriateness of credit unions being liable to pay levies under the mechanism. The Government have taken this feedback on board, and the Bill therefore carves credit unions out of the scope of levies where the new mechanism is used. The Government also acknowledge the questions raised by industry about whether additional safeguards should be included to ensure the Bank of England calls on the Financial Services Compensation Scheme only where this is less costly than putting a bank into insolvency instead. The Government have reflected on this feedback carefully and consider that the safeguards in the existing resolution regime remain appropriate.
However, the Government do intend to update the special resolution regime code of practice in due course, in order to set out how we will ensure clarity on how the Bank of England will consider relative costs to industry in different scenarios. As part of this, the Government intend to set out in the code of practice their expectations around what the Bank of England would need to report on publicly following the exercise of its new powers. Finally, the Government stress that the banking sector as a whole stands to benefit from use of the mechanism set out in the Bill, in particular in its ability to reduce the potential risk of contagion arising from small bank failures where resolution is in the public interest.
I recognise that noble Lords have in the past raised concerns about the exemptions applied when SVB UK was transferred to HSBC and, although these are not within scope of the Bill, may wish to raise such concerns today. It is important to note that the resolution of SVB UK presented an exceptional set of circumstances which required an exceptional response, recognised by noble Lords across the House at the time. The House also supported the conditions that were applied to the exemption, in particular to limit the type of business that SVB UK—now HSBC Innovation Banking—is able to carry out. I am assured that the regulator is in a position to ensure these conditions are met.
I would also like to reassure noble Lords that there is no expectation that ring-fencing provisions would be disapplied in the event of resolution in future; as with many aspects of resolution, they would need to be considered on a case-by-case basis, based on the balance of risks and the public interest at the time. The Government would, though, caution against steps that would create significant new procedural barriers to the use of the transfer tools, given unpredictable situations and the need to act quickly and decisively.
Stability is at the heart of the Government’s agenda for economic growth, because when we do not have economic and financial stability, it is working people who pay the price. The resolution regime is a critical source of stability when banks fail, by ensuring that public funds and taxpayer money are protected. This Bill delivers a proportionate and targeted enhancement to the resolution regime to ensure it best continues to provide that important stability. I look forward to hearing your Lordships’ views on it during this debate. I beg to move.
We then have the FCA. One of the problems that arose in relation to Silicon Valley Bank, which was an unusual species of liquidity risk as opposed to insolvency risk, was that it had a high number of accounts that were accounts of technology companies—that is its specialist business. These were ordinary current accounts for paying the bills and things like that, as businesses have to do. Some of these were large technology companies and some were small technologies companies, but, as a man, they united in saying, “If we can’t actually run our current account on Monday morning when this all opens, there’s going to be the most unholy mess”.
One way of sorting this out in the old days would have been for the Governor of the Bank of England to ring up the chairman of a bank and say, “There are only about a thousand of these customers. Would you mind very much opening current accounts for them, so that we can release some of the funds and they can operate in an ordinary way on Monday morning—we’ll sort out all the details later?” But there is another player up the road, the Financial Conduct Authority, which is not part of the Bank of England, that would not allow any of that at all because there would not be time for the “know your customer” inquiries that have to be made. Another bureaucratic step that we have put in place would have prevented a very simple and obvious solution being put into effect.
I worry whether, when the system is tested properly—Silicon Valley Bank was not a real test of the system—it will be as robust as we would all want to believe it is. Obviously, there is no political point-scoring going on here; we all have the same objective when it comes to trying to ensure the systemic robustness of the banking system in the UK.
To move on from the question of the systemic robustness of the system, there is the question about the Financial Services Compensation Scheme, which is already creaking and is a major charge on the financial system. This will add further to it, in an unpredictable way. It appears that, at the moment, the FSCS operates by way of a levy, which is paid in advance based on the actuarial likelihood of default in particular areas. I assume—the Minister might be able to tell us this—that in this particular case, if recourse was had to the FSCS, it would not be by way of the levy but by a sudden demand presented for money to be supplied immediately: we want it now, out of your reserves. If I have got that wrong, and it is to be part of the levy, some estimate of how much it will increase the levy by would be helpful. It is not clear from the Bill itself which it will be.
In addition to the FSCS levy, which is paid by more or less everybody, banks with equity and liabilities in excess of £20 billion pay the bank levy. As I understand it, the bank levy does not go to the FSCS but straight into the Consolidated Fund and is never seen again. I fully accept the Minister’s contention that there should not be a charge on taxpayer funds. However, if the bank levy is there partly as an insurance premium to help ensure that there is a way of dealing with big banks if they go wrong, maybe that should be looked at before a further dip into the FSCS as a source of funding for the recapitalisation.
I end with three questions for the Minister. First, will he confirm that the bank insolvency process will remain the default, and that recourse to the FSCS as envisaged by the Bill will be the exception and not become routine? I think in his speech he half-confirmed that, but if he was able to reconfirm it for me, that would be helpful.
Secondly, could the Minister tell your Lordships about consequential costs, particularly legal ones? If the process is followed and a bank is recapitalised using FSCS money, but there is then some endless legal dispute that goes on for ever—as there might be, involving shareholders; nobody knows how people are going to respond to these things—will those legal costs be excluded from the FSCS levy so that they could not be recovered from the FSCS? They would be a liability of the Bank of England, because presumably the Bank of England’s conduct would be the subject of any legal action.
Finally, would the Minister like to consider the future of the bank levy and make an assessment, at least, of the effect of the bank levy and the FSCS levy on the competitiveness of banking and financial services in the UK after this further addition to it? I contend that it is becoming very burdensome, and a real charge on domestic banking in a way that is beginning to contribute to what we see on our high streets—which is, frankly, the disappearance of domestic banking and the services that we all so much rely on.
One of the guiding principles is to stay within the overall levy affordability criteria for industry. Does this inevitably mean that timing plays a part? If there is more than one rescue in a short time, will depositors end up somehow getting a worse deal by going through the bankruptcy and insolvency route rather than the resolution route, or will there be a look at the sort of smoothing over time of the burden to the banking and finance sector?
The move in the Bill may also be a psychological one, as it cuts down the demarcation between those banks that have to hold MREL and will be resolved, and those that do not hold MREL and are expected to be allowed to fail. I do not want a consequence further down the track to be a call for small banks to hold MREL. MREL was intended for large banks posing systemic risk and engaging in riskier capital market operations, but it has already crept downwards to mid-sized banks, which do not have capital market operations and for which MREL is unduly expensive. MREL also makes the depositor the enemy, as the highest liability a bank can have is its depositors. This shows in the low rates of interest of those banks with lots of other types of business and in the flight of depositors to smaller banks seeking reasonable rates. MREL in itself is a driver as to where you put your deposits, because otherwise you will not get a decent return, but at the same time, by doing that you are perhaps going somewhere less safe.
Finally, as it must, the Bill amends Section 213 of FSMA 2000 in respect of the FSCS. I take this opportunity to voice again my dissatisfaction with how that scheme works on the FCA side, where the £85,000 guaranteed sum is not actually guaranteed because it suffers deductions to cover administration expenses, as has just been announced in the case of WealthTek, where there is a charge of some £23,000 deducted from the £85,000 guarantee. Once again, the FCA dallied for a year after a whistleblower contacted it about the culprit, John Dance, during which time the situation for investors declined substantially.
It is additionally galling for investors to find the FCA taking the costs of the administration out of what they thought was a guaranteed amount. It is quite easy not to know that this happens. I have asked a lot of the people I work with in the financial sector about whether they know it is not £85,000 on the FCA side, and that you might lose a big chunk of it to the administration. Even many people operating in fund management did not know this themselves. That is probably because it is such a big strapline, but it does not say: “Wahey—you might have expenses taken away from this”. Now, this does not happen on the banking side—at least not yet. I believe this is due to the provisions of the EU deposit guarantee scheme, which I may have had a hand in.
First, can the Minister assure me that, alongside the modifications for use of the Financial Services Compensation Scheme in small bank resolution, and in any domestication yet to come of the retained EU law deposit guarantee scheme, there will not start to be cost deductions from the £85,000 on the PRA side of things? Secondly, on the FCA side of things, I think that that guarantee should be a guarantee, and if costs have to be recouped, then it should be through another route. In the WealthTek case, it said that only 4% of investors fell into the trap of the unexpected deductions. The fact that that is thought to be a small number of investors is all the more reason not to have that trap and discriminate against a small number of investors. Is this something that the Government will look at? Overall, I am not happy that the FCA is in charge of the rules of the scheme that allow it to force the cost of its own dalliance on to the investor guarantee.
In 2008, it fell to the Treasury directly to resolve failing banks. I recall asking the Bank of England whether it would take on the role, thinking that the clue was in the name—it is a bank—and that a bank might be better at taking the necessary steps rather than a government department, but the Bank of England declined my request. Lord Darling put that right in his 2009 Act, which ensured that the resolution authority resides in the Bank of England. In my view, that is the right approach; the Bank of England is better placed to retain the necessary expertise and experience, not least because it can pay its staff more generously.
However, the Treasury needs to remain alert to one important point, which the noble Lord, Lord Moylan, touched on indirectly: the conflict of interest created by the abolition of the Financial Services Authority in 2013. The Bank of England is now the regulator and the resolution authority, and responsible for macro- prudential policy. It also in effect has the power to tax the industry through PRA fees and the wider Bank of England levy. The Bill extends its powers of taxation by allowing it to draw on the Financial Services Compensation Scheme to recapitalise a failing bank. There is nothing wrong with that in principle; it is much better that the industry finances its failures rather than the general taxpayer.
The Bank of England generally does its job well. All I am asking is that Treasury Ministers maintain adequate oversight. To this end, they need to be vigilant to three issues. First, apart from the brief period in 2007 when fear of moral hazard dominated its thinking, the Bank of England has a historical tendency to intervene. I recall Sir Douglas Wass, one of my predecessors at the Treasury, some 40 years after the event still expressing irritation at the Treasury being kept in the dark about the Bank’s intervention in the secondary banking crisis of 1973-74. I can foresee circumstances where the Bank will choose to recapitalise a small bank rather than put it into a bank insolvency process, less because it is in the national interest and more as a way of minimising the reputational damage of regulatory failure.
Secondly, because of the Bank’s power to tax the banking industry, I fear that it will pay insufficient attention to minimising the costs of resolution. I may be wrong, but my recollection is that the Bank of England incurred greater costs, with advisers and so on, in resolving the Dunfermline Building Society than the Treasury did in resolving the Icelandic banks. Unlike the Government, the Bank does not have to stand for re-election, so its incentive to contain costs is rather less.
Finally, it is important that small banks remain well capitalised. Challenger banks are adept at lobbying government and central banks for special treatment, arguing that this enhances competition. To some degree it does, but they are not slow to make political donations. I witnessed this at first hand a decade or so ago. It is important that the authorities ignore these blandishments. As my old friend the noble Lord, Lord King of Lothbury, used to observe, the best way to ensure that the banking system is safe is to ensure that it is adequately capitalised.
I should emphasise that these are minor points that are more about the spirit of Treasury oversight than the substance, and I am happy to support the Bill.
That is why it is particularly welcome that the Bill makes no provision for increased funding burdens on small banks such as MREL provisions. Britain already suffers from the fact that necessary prudential regulation creates an anti-competitive environment in banking, making it particularly difficult for small banks to cover compliance costs. We should not make the task of small and challenger banks even more difficult.
All this adds up to a valuable and proportionate piece of legislation. Unfortunately, the documentation provided in support of the legislation contains a number of disturbing propositions that take some of the shine off the Bill. For example, in the Treasury document replying to the consultation on the Bill we find the following proposition:
“Noting that the expectation is that the mechanism would generally be used to support the resolution of small banks, the government considers it appropriate for the mechanism to be, in principle, applicable to any banking institution within scope of the resolution regime”.
So, this procedure is not deemed to be targeted solely at small banks but might apply to banks of any size. Perhaps the Minister could enlighten us as to what the Treasury has in mind?
Most disturbing of all is the evident belief, held by both the Treasury and the Bank of England, that this new resolution mechanism can deal not just with idiosyncratic risk—that is, failures in just one or two banks at a time—but also with systemic risk: failure impacting the system as a whole. Consider this statement in the Bank of England’s guide to resolution entitled The Bank of England’s Approach to Resolution:
“The need for a financial system to have an effective resolution framework was a key lesson from the global financial crisis of 2007-09. During the crisis, governments had to resort to ‘bailouts’ as some banks had become too big, complex, and interconnected to be put into insolvency like other types of firms. Without a resolution regime, letting them fail would have meant that people or businesses would have been unable to access their money or make payments. The potential risks to the financial system and the economy meant they had become ‘too big to fail’”.
Now it goes on:
“Resolution changes this by providing powers to impose losses on investors in failed banks while ensuring the critical functions of the bank continue”.
Well, I hope and pray that the Bank of England does not believe this nonsense. The ability of a resolution regime to protect the taxpayer depends on the proposition that the banking services can be maintained by sale of the failing bank to a competent and well-funded counter- part. But, in a systemic crisis such as 2007-09, this is impossible because there are no buyers. Everyone is in trouble. In these circumstances, there are only two answers: bailouts by the taxpayer or insolvency.
Size matters, too. When Credit Suisse failed, the Swiss authorities immediately abandoned any pretence at resolution; only public funds could handle the job. This is not just true in the case of a large bank failing. As the Treasury consultation document notes,
“while an individual institution may not be considered systemic, if a risk is common—or perceived to be common—among similar institutions, the collective impact can pose a systemic risk”.
In other words, the failure of many small banks all at once can be as devastating as the failure of a large bank. But, having made this very sensible point, the Treasury goes on to suggest that somehow “targeted resolution” will sort things out. It would seem that both the Treasury and the Bank of England are prone to wishful thinking.
It is also worth noting that, in the face of a systemic crisis, the levy proposed in the Bill, which is designed to fund the demands on the FSCS, would be a powerful source of crisis contagion. I note that the Treasury is taking steps to limit such contagion.
There is one small irritation with the documentation that is important for later stages of the Bill. The cost- benefit analysis presented by the Treasury has little relevance to the Bill’s subject matter. It compares costs and benefits of the resolution regime with the alternative of insolvency, but that is not the issue here, which is the comparison of the costs and benefits of the new funding mechanism as an addition to the old resolution regime, as set out in the Banking Act 2009. I suspect that the benefits, predominantly of flexibility, are small and that the changes in costs are negligible, even though the allocation of costs is now different. Could we please have a relevant cost-benefit calculation for later stages of the Bill?
This is a very useful measure to deal with the failure of small banks in circumstances in which the rest of the banking system is in rude health. Please let us not pretend that it is anything else.
Secondly, and this goes to a point that the noble Lord, Lord Eatwell, raised, the letter that the Minister kindly sent explaining the Bill states in the first paragraph:
“The Bill enhances the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of small banks”.
The Minister said that in his opening words as well, so could he explain why the Bill applies to all banks, including those inside the MREL regime?
Under the Bill, any costs of putting a bank into a resolution procedure, either by transferring it to a private sector purchaser, as happened with SVB, or by transferring it to a bridge bank with a view to ultimately transferring to a private sector purchaser or insolvency, will be met by funds provided by the industry via the FSCS. The Government indicate that in most cases they expect the costs to be lower than putting the bank into insolvency because it should avoid compensating depositors up to £85,000 each. The costs that the FSCS would cover would include the costs of recapitalising the failed bank, the operating costs of the bridge bank, and any costs in relation to the resolution, including legal and other professional expenses, costs of valuation and other associated costs incurred by both the Treasury and the Bank of England.
That raises a number of questions. What cap or limitation is there on the costs? While the Government say that they expect costs generally to be lower than insolvency, and they are probably right, that is not guaranteed. The bridge bank could be run for up to two years, and that is extendable in certain circumstances, so this could become quite a large, open-ended cost. Who controls the level of costs during the period? I think the noble Lord, Lord Macpherson, talked about this. It is not those who are going to be paying for it, so there is no direct incentive to keep the costs as low as possible. How is that going to be scrutinised? What input will those who ultimately pick up the costs have?
Under an insolvency process, there is a de facto cap on the liability to the FSCS, and therefore the industry, which is the amount of the deposit protection. Is it right that the wider industry will potentially be on the hook for paying more than that de facto cap? As I understand it, this process will be used only—and I think the Minister mentioned this—if it is in the public interest to do so, where a small bank failure turns out to create systemic risk. That would reflect a failure by the PRA to identify a systemic risk, as I mentioned earlier. If the resolution decision is driven by a public interest test, surely it should be the public purse that pays the excess rather than the banks which have no part in this. As a matter of principle, it is shareholders, lenders and other creditors who should bear the primary risk before the industry is asked to contribute. The industry should not be underwriting any debt or equity or even supplier risk. What is the mechanism for ensuring that the resolution process will not unfairly benefit share- holders or other creditors?
Related to that, if a bank is transferred to a bridge bank and two or even more years later goes into insolvency, where will the FSCS money that has been poured into the bank in the meantime rank in the hierarchy of debts? It should presumably rank above all debts that existed on the day the bank was transferred to the bridge. Is there a mechanism for returning money to the FSCS and to industry if it can be recovered either in insolvency or a sale? To go further than that, any sale to a private sector purchaser in these circumstances is typically under fire sale conditions, so they usually happen at below market price. SVB UK was transferred to HSBC for £1, as I mentioned, and HSBC is widely seen as having got rather a bargain because the failure of SVB was not caused by the UK entity; there was nothing wrong with the UK entity. SVB UK had loans of around £5.5 billion and deposits of around £6.7 billion and in the previous financial year had recorded a profit before tax of £88 million. Its tangible equity was around £1.4 billion, so quite a bargain at £1.
Will there be or should there be a mechanism for clawing back any excess profits made by the private sector purchaser to be refunded to the FSCS if the FSCS has provided the resolution financing? What happens if the failed bank is a subsidiary of an overseas entity? What mechanisms do we have for ensuring that the parent company pays for the costs of such a failure and not the FSCS? Why should the UK banking industry pick up the costs if there is a viable overseas entity? I realise that was not the case with SVB, but there could be a situation where an overseas bank sets up a UK subsidiary that does not go very well so it just walks away from it. It should pick up those costs. Is there a process for clawing back management bonuses and dividends paid prior to the failure?
As a general principle, bad or failing businesses should be allowed to fail, and that may mean that creditors, including depositors beyond the protection cap, lose money. There is a risk that this mechanism could be used to avoid negative headlines or for political or reputational expediency. After all, as was said before, the costs of taking the action will not fall on those making the decisions. Ultimately, the costs will be borne by consumers as the banks pass them on in low savings rates, higher lending rates or higher charges. What safeguards are in place to ensure that the mechanism is used only in appropriate circumstances? I am broadly supportive, but I have a lot of questions and look forward to hearing from the Minister.
Under the Bill, the cost of reckless practices at one bank would be borne by others, as the FSCS would raise levies on other banks. There are clear moral hazard issues here, especially as the boards of the failing banks do not face personal consequences and shareholders have only a short-term interest. Will the Minister explain how these moral hazards would be checked by the regime proposed?
We all know from history that rescue and recapitalisation is not the only way that the Bank of England and the Government rescue banks; they also engage in deceit, skulduggery and cover-up. The classic case relates to HSBC, which in 2012 was fined $1.9 billion by the US regulators for money laundering. At that time, it was the largest ever fine on a corporation. According to the US Department of Justice, HSBC
“accepted responsibility for its criminal conduct and that of its employees”.
The bank was regulated by the UK authorities, which took absolutely no action. In March 2013, the US House of Representatives Financial Services Committee began a review of the US Department of Justice’s decision not to prosecute HSBC or any of its employees or executives for admitted criminal activities. Its July 2016 report titled Too Big to Jail contained a two-page letter from the then Chancellor, George Osborne, and extracts of correspondence with the Financial Services Authority and the Bank of England. The Chancellor’s letter, dated 10 September 2012, urged the US authorities to go easy on HSBC as it was too big to fail. It also urged the US authorities to go easy on Standard Chartered Bank, which was fined £330 million for money laundering and for sanctions busting. Despite requests, which I have made in this House, no statement has ever been made to Parliament.
No documents have been placed on public record to show why banks are being rescued by deceit and cover-up, and this inevitably emboldens banks. In 2019, Standard Chartered was again fined for money laundering and sanctions busting—this time for $1.1 billion—and HSBC has been a habitual offender. Can the Minister explain why these matters are not being looked at? The institutionalised corruption increases the likelihood of banking failures. It would be helpful to know what steps the Government will take to cleanse the City of London. Simply saying “We will recapitalise banks” will not do.
The Bill rests on very shaky regulatory foundations. After the 2007-08 crash, the regulators’ duty to promote the industry was abolished and they were primarily required to be what I call watchdogs and guide dogs. The last Government changed that legislation and now regulators are required to promote competitiveness and growth of the industry. The regulators have effectively become puppies and lapdogs of the industry. Regulatory actions requiring stringent oversight or lower gearing ratios could be interpreted as a tax on competitiveness and the potential growth of the industry. Such conflicts were considered to be contributory factors in the 2007-08 crash, but they are now back on the statute books.
Lehman Brothers had a leverage of 30.7:1 when it crashed and Bear Stearns had a leverage of 36.1. On the one hand, the Bank of England and regulators tell the banks that they must be well capitalised; on the other hand, tax relief is offered on interest payments on the debt. Government incentivise taking on leverage. How can that create stability? Why do the Government not abolish the tax relief on interest payments by corporations? That would certainly reduce their financial risks and vulnerability. Again, I look forward to hearing from the Minister.
The current regulatory environment is much weaker than the pre-crash environment. Shadow banks are the new elephant in the room. Shadow banks include hedge funds and private equity, and all are unregulated. They are meshed with the retail and investment banks, insurance companies and pension funds but remain unregulated and totally opaque. Some parts of this industry are located in offshore tax havens, and it is impossible to see their financial statements and make any meaningful assessment of the risks and dangers that they pose to the banking system.
Private equity and hedge funds function as banks, but they are not subject to any minimum capital requirements, control on leverage or stress tests, even though the collapse of one firm can destabilise the whole sector. The collapse of the US-based Archegos Capital Management showed how rapidly the domino effects occur and had immediate negative effects on the capital buffers of Goldman Sachs, Morgan Stanley, UBS and Credit Suisse. Banks that are regulated in the UK now have multiple connections with shadow banks, including lending to buyout companies and the funds that acquire them, the firms that manage them and the investors that back them. There is a complex web that is impossible to penetrate, and that will ultimately bring forward a crash. In April this year, a Bank of England official responsible for financial stability, strategy and risk said that there were serious
“questions about the risks of these financing arrangements, and the growth in kinds and quantity of leverage, or ‘leverage on leverage’, throughout the ecosystem”.
Successive Governments have failed to bring shadow banks within the scope of regulation. A deeper crisis is being incubated, just as it was before the last crash. When the next crash comes—and it will come—it will engulf every sector of the economy, as private equity is into supermarkets, hospitals, GP surgeries, water, care homes, cosmetics, housing, property, hotels, insurance and everything else. There will not be enough money to rescue, so we need to strengthen the regulatory system now. The recapitalisation regime of this Bill will not be able to cope.
Of course, Ministers can dismiss the kinds of concerns that I have expressed, but it would be most unfortunate if the next crash was to come during the term of the Labour Government in office. Does the Minister know how many entities regulated by the FCA are enmeshed with shadow banks and what their risk exposure is? I have been unable to work that out by looking at the accounts of these organisations, but the Minister may have superior information. If he does have it, can I ask him to publish that data?
Shadow banking is now a major danger to the stability of the financial system and its practices can undermine the regulated banks, but shadow banks are not required to contribute to the recapitalisation fund. Why is it that they can create risks for the entire system but do not bear the cost? Can the Minister explain how much they will contribute to this recapitalisation fund and whether he considers their contribution to be adequate?
I want also to pick up the point raised by the noble Lord, Lord Moylan. If there is to be trouble on a large scale and, as a consequence, the FSCS is turning to the banking system as a whole and asking for very large payments, does anybody within this chain have the ability to waive that and just say, “No, this demand is excessive. We are going to ask for a smaller portion from the banking system, or we are simply going to say, ‘This crisis is sufficiently large that we are going to turn to the taxpayer’”? To me, it is not realistic to suggest that, under every circumstance, the FSCS could turn to the banking system and be fully reimbursed. I would be grateful if the Minister enlarged on that. I am glad that he said that credit unions have been exempted from the levy. It would have been entirely improper to include them.
I have some related questions. The Minister knows that I was troubled by the sale of SVB UK. As the noble Lord, Lord Vaux, said, HSBC buying it for £1 was a real giveaway. HSBC played hardball, as it would, so the Government did not have a lot of choice. As the Minister knows—I have raised this before, and he referred to it in his speech—I still regard the terms of that sale as a mechanism which provided HSBC with a route to evading the ring-fencing rules that would normally apply to its retail banking, in order to separate it from investment banking activity.
When I raised this issue in Grand Committee, the Minister of the day was unable to give any kind of satisfactory answer. As far as I could tell, there was nothing to stop HSBC transferring those assets over to its Silicon Valley Bank entity, where it could engage in derivatives and securitisation on any scale it wished. If this final solution is now different, would he mind writing to me? It is probably impossible to answer that question now, but perhaps he would put a letter in the Library that makes it clear why busting the ring-fence was not a consequence of the way that sale was structured. That would be exceedingly helpful. As my noble friend Lady Bowles asked, could we get some assurances that, if the resolution pattern established for Silicon Valley Bank is going to be repeated, there will be measures in place to make sure that it does not become a backdoor to evading ring-fencing constraints? Following the 2008 crash, most of us—both in this House and in the other place—recognise that ring-fencing is a critical part of the defence against a repeat of the kind of crisis we saw back then.
As I say, I have long been sceptical of all schemes to resolve small banks, but, frankly, I am also somewhat sceptical of the plans to resolve large and medium-sized ones—those identified as systemic. As others and the Minister said, large and medium-sized banks are required to hold MREL—basically, bail-in bonds, to put it in English—to protect or provide a route to resolution. But, as the noble Lord, Lord Eatwell, said, when Credit Suisse collapsed in 2023, the Swiss regulators immediately realised that the consequences of implementing its resolution plan would lead to lasting damage to the Swiss economy. Swiss regulators are not fools or softies; they were facing the absolute reality that, with a failure of a bank of that size, they could not allow the backstop of wiping out shareholders or owners of convertible bonds. In effect, they organised a takeover of Credit Suisse by UBS. So does the Minister really expect that our regulators will implement the current bail-in resolution schemes, or will we also find that “too big to fail” still rules the day? It is time to be honest about this—with a new Government, perhaps it is time to look at this again much more directly.
Will the Minister also pick up an issue raised by my noble friend Lady Bowles: MREL and medium-sized banks? As she said, the market for bail-in bonds for medium-sized banks is so small that it is almost non-existent, so the bonds are exceedingly expensive. The consequence is that UK banks are now choosing not to grow from small into big because they see no way to put in place the MREL layer that would be required under current PRA regulations. Even if they did, because of the price they would have to pay for those bail-in bonds, they would face a competitive disadvantage compared to the big banks, which access a much more liquid bail-in regime. Is now not the time to take another look at the medium-sized banks and see whether a better scheme could be devised for their resolution, rather than assuming that MREL will be an adequate way for them to put in place that kind of protection?
I draw the Minister’s attention to the other issues raised by my noble friend Lady Bowles and ask for a full response. We are supportive of the Bill. We will look at it in Committee to see whether any amendments could improve it, but, as I say, this is the first time I have looked at a piece of banking resolution legislation and thought, “Actually, that could work in practice, not just on paper”.