This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government
Speech by the Commercial Secretary to the Treasury.
[Check against delivery]
Thank you Philip [Hampton].
And thank you Guy [Morton] to you and your Freshfields colleagues for hosting tonight.
It’s a great pleasure to address so many of you from the banking industry and a great honour to be delivering this inaugural BBA summer lecture.
I would like to start by thanking Angela Knight, who, I am sure you will all agree, has been an outstanding voice for British banking for the past five years.
It was not exactly perfect timing to be appointed to head the BBA in April 2007. And Angela, you could well feel hard done by, that the ‘New Golden Age of British Banking’ - which was predicted to begin that year - didn’t quite turn out as planned.
But, Angela, the country owes you a considerable debt of gratitude. During the Northern Rock crisis, when official spokesmen, and I stress spokes’men’, were either invisible or incredible on the media, you were a steady, calm and clear voice throughout.
And in the past two years you have worked with great vigour, with Stephen Green, John Varley and Marcus Agius, to rebuild banking’s relationship with government. And, more importantly, with the industry’s customers.
Angela, thank you for your contribution to the industry and best wishes as you take your boundless energy into your new role, in the energy industry.
Now I would like to focus this evening on some of the work that has been done - and the work that still needs to be done - to secure the future of the UK as the world’s number one financial hub. And what we need to do truly to bring about a new Golden age for British banking - one that is some improvement on the pre-2008 model.
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However it may feel at times to you in the industry, this is a government that wants to see a thriving banking industry. Not just to support the rest of the economy but to be a world leading, successful industry in its own right.
Now, you still don’t always make it easy for us - or for yourselves - every board pay dispute, every new misselling scandal, every deserving SME refused credit, complicates our shared agenda - but we will, of course, plough on.
And let me start by addressing the most pressing threat to the competitiveness of UK’s banks - the euro zone crisis and what it may mean for the single market.
Closer fiscal integration in the euro zone may require a, so-called, banking union. On the other hand, a single market in banking does not require a banking union.
I believe that starting point is now well understood in Europe, if not completely accepted by all. As is our determination both to remain part of the single market and also to drive forward completion of that market.
Now a banking union has three basic elements to it and we need to be thinking about each of them separately: depositor protection, supervision and the rule book.
On depositor protection, the UK will not be part of a euro zone scheme. UK taxpayers won’t agree to underwrite euro zone bank depositors - so let’s recognise that up front and be clear about it.
On bank supervision, we are not going to throw away all that we have done to learn the lessons of the crisis. Prudential regulation and supervision will be with the Bank of England. And that is where it will stay.
It is the rule book which presents the area of greatest potential difficulty. Of course, we continue to believe in the principle of a common EU rule book. But safeguards will be required to ensure the integrity of the single market - to guard against discrimination against non-Eurozone countries. The Chancellor and the Prime Minister are very well aware of the importance of the issue. We did a lot of thinking in preparation for last December’s European Council. And we will fight tirelessly to ensure that the appropriate safeguards are put in place.
And while this is the really big question for banking in Europe at the moment, it is also important that we do not allow regulation to worsen the existing problems that Europe faces.
I carefully read the BBA’s own Banking Industry report, published last month, which rightly drew attention to the negative effect that global regulation and the uncertainty around it was having on the industry.
We must not allow innovation to be stifled in the name of stability. So, we are strongly resisting the Commission’s proposals for a Financial Transaction Tax. A proposal that would harm growth, increase market volatility and drive business away from Europe is insane.
Similarly, we are challenging the ECB’s location policy in the European Courts. Because it is not acceptable for a body that is meant to promote single market principles to force clearing houses dealing with large Euro based transactions to locate within the Eurozone.
The recent proposals from the European Parliament that variable remuneration should be limited to no more than fixed pay are also of concern.
Capping variable remuneration in this way will inevitably lead to an increase in fixed costs as banks increase fixed pay. This means that much of the progress made in recent years to align risk with reward, through deferral and claw backs, will be lost.
The proposal, if enacted, would also make it more difficult for banks to retain capital in a stress scenario, and would also make it harder for financial institutions to claw back pay in cases of poor performance - reducing the alignment of employee incentives and risk.
Both at the BBA and in her previous role at APCIMS, Angela has been the master at how to lobby effectively in Brussels.
Teaming up to present solutions to the Commission which present a broad European view. Presenting Brussels officials with specific drafting to improve the text of directives.
I recognise that the Government needs to do better in the way we interface with the Commission. Only last week, for example, I asked my financial crime team why we couldn’t be more like Angela and offer up specific drafting suggestions to deal with issues we have with the Commission’s review of the third Money Laundering Directive.
And we need more able British officials in key positions in Brussels.
But if the European regulatory agenda is challenging, there is also still much to be done in the UK.
A well regulated sector is key to competitiveness, reassuring customers that they can have confidence in the markets they are using. A strong and proportionate regulatory system is an essential platform for the success of the City; not a hindrance to it.
This is close to my heart. From the end of 2002 to the end of 2005, I chaired the monthly meetings of the Tripartite Standing Committee Deputies. Even then, well before the crisis hit, some of the basic flaws in the Tripartite system were all too clear.
The Bank of England’s financial stability team were producing high quality analysis already identifying some of the key issues that would be at the heart of the crisis. For example, the over-reliance of Northern Rock on wholesale funding, the extent of Bradford and Bingley’s exposure to the buy-to-let market, RBS’s increasing exposures in Germany and elsewhere.
Sir Andrew Large, who was then the Deputy Governor for Financial Stability, came to those monthly meetings in 2005 already ringing the alarm bells. And, to digress for a moment, Andrew and the late Tommaso Paddoa-Schioppa, who went on to be finance minister of Italy, were the only two central bankers who in 2004 and 2005 were coming to the six monthly meetings of the Financial Stability Forum and identifying some of the asset price and leverage issues which would be exposed in 2007 and 2008. They were the only two voices that I heard standing out against the orthodoxy - the central banking, regulatory and finance ministry thinking that all would be well with the system.
Sadly, we all listened but took no action.
Back in the UK in that period, the Bank of England actually scaled back its financial stability division. The Bank had a non-statutory financial stability remit but it had no tools, no levers to translate its concerns into action. Nor did it ask to be given such tools.
And the FSA was at the tripartite meetings but did next to nothing to follow up on the analysis which the Bank presented.
We did work hard on crisis management issues - but these were mostly directed at operational disruption. For example, on how the sector would handle a 9/11-style attack on London.
There were some financial crisis war games. I well remember an excellent re-run of the Barings crisis put together by the Bank and played out over several hours. The Governor and the Chairman of the FSA took part but I failed to persuade Treasury ministers to join in. I had to play the role of the Chancellor. If Treasury ministers had been there, they would have learned invaluable lessons about how the three parties would react and inter-relate in a crisis. Lessons that would have had a direct, and beneficial, impact when it came to Northern Rock in 2007.
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But, having been out of the system during the crisis itself, I spent much of 2008/9 thinking about what would make for a better system of financial sector regulation.
And now I find myself this month taking the Financial Services Bill through the House of Lords.
The Bill will ensure regulation is strong and proportionate; replacing the failed and discredited tripartite system of supervision.
After several rounds of consultation and scrutiny, I believe the Bill is in good shape but I know that it is going to be under the microscope, with very tough scrutiny indeed in the Lords in the coming weeks.
I have to be rather careful what I say about the Lords but I found it very remarkable that in our seven hour Second Reading debate last week, the Bill was debated by two former Chancellors, numerous other former Treasury ministers, three former Treasury Permanent Secretaries, at least two former members of the Court of the Bank, a chairman and other board members of our largest banks and insurers, one of our most distinguished financial journalists, a leading market economist… and I could go on. What other legislative chamber in the world could match that?
And I can tell you that to be the minister on the receiving end of all that is both incredibly stimulating but also absolutely terrifying!
I won’t talk at length about the new structure. You all know the details. But in summary, a new Prudential Regulation Authority, a subsidiary of the Bank of England, will take responsibility for micro-prudential regulation. The PRA will secure the safety and soundness of firms with significant risks on their own balance sheets and give counterparties the confidence they need to do business with major UK institutions.
The new Financial Conduct Authority will exercise proportionate regulatory power to promote clean, fair and efficient markets.
And the Bank’s new Financial Policy Committee will monitor risks across the financial system, identifying bubbles as they develop, spotting dangerous interconnections across the system, and stopping excessive leverage before it’s too late.
Together, these bodies will bring judgement and foresight to the task of supervision and, through increasing confidence in the City, will help underpin London’s position in world markets.
Some question whether having so much authority under the roof of the Bank will lead to excessive group think. Well, as I have explained, the Tripartite certainly did not avoid the group think problem. And with powerful independent members on both the FPC and the PRA, I believe that there will be sufficient challenge of the Bank insiders.
I accept, though, that the reforms risk being largely a deckchair moving exercise if the attitudes to regulation of the FSA’s successor bodies, the FCA and the PRA, don’t change very significantly.
Time will tell. But I welcome the fact that the chief executive of the FCA, Martin Wheatley, is a former senior market practitioner and someone who has run a regulator outside the UK. Martin comes back to the UK with a wealth of fresh ideas and varied experiences.
And on the PRA side, I want to read an extract from what Sir Mervyn King said in his Mansion House speech a year ago because I found it hugely encouraging. This is what the Governor said:
“The style of regulation will also change with the PRA. Process - more reporting, more regulators, more committees - does not lead to a safer banking system.
One of the reasons for putting the PRA inside a central bank is to integrate the work of the two institutions more closely. In particular, the market intelligence team at the Bank will work closely with the supervisory body. I believe that we can operate prudential supervision at lower cost than hitherto by reducing the burden of routine data collection and focusing on the major risks to the system. It is vital that we collect and process data only where the supervisors have a need to know. Targeted and focused regulation, allowing senior supervisors to exercise their judgement, does not require ever-increasing resources.
For example, we will reduce the number of people subject to the intensive regulatory interview process before appointment by limiting such interviews to the most senior people. And one of the benefits will, I hope, be to make entry into UK banking easier and so promote competition.”
That’s what the Governor had to say. And if the Bank delivers on that manifesto, we will have made huge strides forward. And I believe that the Bank will deliver. I know that two years ago, the Governor set his team the challenge of becoming the best bank supervisor in the world. They are working tirelessly to that end.
Of the remaining major concerns people have with the Bill, we will be bringing forward amendments to strengthen governance of the Bank.
We agreed with the Vickers Commission and introduced an amendment to give the FCA a competition objective. We don’t, though, see the need for an explicit international competitiveness objective. We believe that it is getting the substance right - proportional, fair, transparent regulation - which will lead to a more competitive London and UK sector - not the introduction of a further competitive markets objective of an ill-defined kind.
But at the macro level, we have to worry that we don’t create a system that is stable but sclerotic. What the Chancellor has called “the stability of the graveyard.”
I heard those worries expressed forcibly from all side of the House of Lords last Monday, as they had been in the Commons. And that is why we responded immediately, with the Chancellor announcing on Thursday at the Mansion House that the FPC will have a subsidiary growth objective. An objective which will be drafted in similar terms to that of the MPC.
And when it comes to the structure of banking, we are alive to similar growth and competitiveness issues.
Last week, we published the White Paper setting out how the Government plans to implement the Independent Commission on Banking’s recommendations in detail.
High-street banking will be ring-fenced so that taxpayers are better protected when things go wrong.
We will be able to bail in creditors when a bank fails rather than turning to the public purse.
But we recognise the special position of UK banks with large overseas deposits and have accommodated their further concerns.
And we will watch international developments before imposing a fixed leverage ratio. The Vickers Commission may not be happy that we are more cautious than them on the leverage ratio. But with a leverage ratio of 3% rather than 4%, UK banks will compete on a more level playing field. And the leverage ratio will be a backstop rather than a front stop.
Now, banking will only thrive in the UK if we get a whole raft of non-banking issues right. I want to touch on a few of them. We are a Government that is utterly committed to ensuring the UK is open to business and that London continues to thrive as a leading global economic centre.
To that end, we are making our tax regime much more competitive and improving infrastructure to make this a place where businesses locate, thrive and grow.
A competitive tax regime is the bedrock of a successful economy in an increasingly globalised world. Employers and employees alike are more flexible than ever about where and how they operate.
So we are giving businesses an incentive to locate here, and ensuring that enterprise and innovation is rewarded. We are cutting Corporation Tax to 22 per cent by April 2014 - the lowest rate in the G7. And yes, I fully acknowledge that for our large banks, that is offset by the introduction of the bank levy.
And we are enabling banks and other businesses to attract the talent they need to thrive and grow, by reducing the top rate of income tax from 50 per cent to 45 per cent from April 2013. That will make the top rate of income tax lower than that in France, Germany, Canada, Australia, Japan and Italy.
And for globally mobile companies whose headquarters we want to attract here, the changes to the controlled foreign company rules will often be a key factor.
As well as a tax system geared towards growth, London needs world leading infrastructure. That is why we are investing in improving London’s transport to ensure businesses have the connectivity they need.
So it was critical that in 2010 we reconfirmed the £14.5 billion of private and public sector investment in Crossrail. One of the largest engineering projects in Europe. And a project that will help transform getting in, out and across London.
We recognise the various dimensions of the South-East airports challenge and will not shy away from them.
Whether it is the short term issue of the unforgivable experiences many of us have suffered getting through Heathrow Terminal Five - on which the Home Office have been working actively - or the short to medium term challenge of better using our existing airport capacity; or of how to maintain a hub airport of global status, we won’t duck the tough decisions.
And of course - we must also fight to ensure that we can’t just fly to new markets but that those markets remain open and that we ward off the spectre of protectionism, whether deliberate or unintentional.
Restrictive third country regimes that are currently being proposed in the EU, which impose requirements that no country outside the EU would meet, benefit no-one. And resisting these will continue to be a Government imperative.
We are working, and will continue to work, to make sure the UK and the EU remain open for business and don’t close their borders to global firms wanting to provide their services here.
In a globalised world, prosperity lies in opening our arms to opportunities abroad. So as well as fighting off regulations that shut us off, the Government is refocusing our international efforts on economic priorities for the UK.
And while progress has been glacial on multilateral agreement under Doha, we have strongly supported and encouraged the EU to pursue deep and strategic bilateral Free Trade Agreements. These represent major opportunities for opening up trade in financial services in priority markets. For example, the EU is currently negotiating FTAs that are of specific importance in terms of financial services, and therefore to the UK, with India, Singapore, Mercosur, Canada, and Malaysia.
So, in summary, a regulatory regime that is simple and proportionate. A competitive tax regime that encourages and rewards the right decisions.
Modern infrastructure that supports twenty first century business.
And an approach to global markets that acknowledges that an open economy that reaches out abroad benefits everyone.
While we still have much to do, the steps we are taking are yielding results, with lots of signs that the UK is seen once more as an attractive place to do business.
While other Western financial centres have lost their competitive edge, London has strengthened its position as number one in the global index. Key players across the sector are locating here.
Earlier this year, AON, the world’s largest risk management company and a major operator in the London insurance market, announced the move of its headquarters to London. The first S&P 500 company ever to be headquartered in the UK.
PricewaterhouseCoopers believes that 10 to 15 multinationals are considering locating substantial operations here because of our corporate tax reforms.
The actions of firms from across the globe reflect London’s position as a global leader, not just in finance generally, but in specific growth areas.
So, for example, Lancashire Group, the speciality insurance underwriter, has relocated from Bermuda to London.
The leading high-tech financier, Silicon Valley Bank, is this month opening in London, reflecting the mushrooming success of Tech City in East London.
In sovereign wealth funds, where funds holding half of the sovereign wealth assets in the world have offices in London, there are moves to increase the number of specialist infrastructure teams based here.
Perhaps, more surprisingly, UK financial institutions are the largest financers of emerging markets. $862 billion - 19 per cent of the lending outstanding to emerging markets at the end of 2010 - came from London; and UK banks account for around 30 per cent of lending to China, India and Malaysia.
All of this is achieved through a London that looks out beyond Europe’s borders to form new links with partners abroad.
That is why we put London’s role as a centre for trading RMB at the heart of the Chancellor’s economic and financial dialogue with the Chinese Vice Premier last year.
HSBC has already launched a landmark 2 billion RMB bond issue, the first such issue outside of Chinese sovereign territory. Originally expected to be 1bn RMB, but increased when it was oversubscribed four times over.
The rapid success of this great project, which has been facilitated by Government, but ultimately led by the private sector, is testimony to what the banking sector itself can achieve to take advantage of global opportunities.
And perhaps none of those new links is more important than our increasing economic partnership with China, an economy expected to surpass the US in size to become the largest in the world possibly within the next 15 years. Already the country is responsible for 10 per cent of world trade, and conducting an increasingly large proportion of that trade in its own currency. As the world’s economic focus shifts, it is vital that we are not left behind.
It is up to you - British-based banks - to ensure the world knows that a strong city is good for everyone - and not just for the UK.
Ensuring that message is heard means more opportunities globally, and less risk of disproportionate regulation from the EU and beyond.
Government has its part to play, but ultimately that message must come from the City itself and the BBA must play a major role in that.