This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government
Statement by the Financial Secretary to the Treasury.
[Check against delivery]
With your permission Mr Speaker, I would like to make a statement on banking reform.
Mr Speaker, the financial crisis exposed a great many flaws in the system.
Banks borrowed too much, took risks they did not understand, and bought securities that proved to be far from secure.
Banking groups became too complex and interconnected to be managed effectively.
Regulators failed to identify the risks.
And taxpayers paid the price. Between October 2008 and December 2010 European taxpayers provided almost €300bn to prop up their banks, with liquidity and lending support in the trillions.
And in the UK, the bail out of RBS was the biggest banking bail out in the world.
And just as the crisis revealed many flaws, there is no single solution.
This Government is reforming the substance and structure of the financial architecture, putting the Bank of England in charge of prudential regulation.
We have created the Financial Policy Committee to look at risks across the financial system.
Our permanent bank levy penalises short-term wholesale funding and we have introduced the toughest and most transparent pay regime of any major financial centre in the world.
And we have worked with our international partners to deliver robust, consistent standards on prudential standards for banks and markets.
The White Paper we are publishing today, Mr Speaker, sets out how we will implement the recommendations of the Independent Commission on Banking.
These reforms form a key part of this Government’s broader programme of reform.
In the same way that the action we have taken on the deficit has meant that UK debt is currently seen as a safe haven asset by investors around the world, we will ensure that British banks will be resilient, stable and competitive, and so attractive to investors at home and abroad.
The Eurozone crisis makes reform more, not less, important. The link between the strength of a country’s banking sector and its own stability could not be clearer.
At the same time, our proposals reflect progress that has been made in European and international regulation since December.
The Government welcomes the European Commission’s Recovery and Resolution Directive that will improve Member States ability to resolve cross border banks without imposing costs on taxpayers.
And, Mr Speaker, this Government will continue to press for full implementation of Basel III in Europe.
The goals of today’s White Paper are clear.
First, since future financial crises rarely repeat the pattern of the past, we must make banks more resilient to shocks.
Second, we must make our banks more resolvable so that, if they fail, they don’t threaten the provision of vital services to the real economy.
Seeing through these two goals will achieve our third - to curb risk taking in financial markets. It must be clear that investors reap rewards when banks do well, but take the pain if banks fail.
Mr Speaker, the Government will ring-fence retail deposits from the risks posed by international wholesale and investment banking.
A ring-fenced bank will be economically and legally separate from the rest of its group, and run by an independent board.
The ring-fence won’t stop a bank failing, but it will insulate the deposits of families and businesses and, if a bank does fail, these essential parts of the banking system can continue without recourse to the taxpayer.
The deposits of individuals and their overdrafts, and the deposits and overdrafts of small and medium-sized businesses will, in general, be placed in ring-fenced banks.
To minimise the risks that the ring-fenced bank is exposed to, it will be prohibited from conducting the vast majority of international wholesale and investment banking.
It will not be permitted to carry out activities through branches or subsidiaries outside the EEA, nor, except in limited circumstances, with financial institutions.
Beyond this, and within certain constraints, firms may decide what to put inside the ring-fence.
Ring-fencing provides customers with flexibility, but not at the cost of financial stability.
And the Government proposes to strengthen the ICB’s recommendations by applying strict controls on the use of derivatives a ring-fenced bank uses to hedge its own balance sheet.
This will ensure that a ring-fenced bank does not take excessive risks when managing its own risks, as was the case in JP Morgan’s recent much publicised trading loss.
Mr Speaker, governance of the ring-fenced bank will be important. The Government proposes to strengthen the ICB recommendations in this area, establishing separate risk and possibly remuneration committees.
But it is important to focus these reforms where they have the biggest impact, that is, on the biggest, too-big-too-fail banks.
So the Government proposes that smaller banks, with below £25bn of mandated deposits be exempt from these requirements.
Large, systemically important banks have a competitive advantage from the perceived implicit guarantee. Or targeted reforms remove that advantage, helping smaller banks and new entrants.
Mr Speaker, one of the clearest lessons from the crisis is that investors and creditors - not taxpayers - should bear the costs of failure.
That’s why we have supported Basel III, which increases banks’ capital requirements to 7%, with a top up for systemically important banks, and we have pressed for it to be implemented across Europe.
But to protect taxpayers, this Government will go further.
The largest UK ring-fenced banks should hold an additional 3 per cent of equity on top of the Basel III minimum standards.
The Government also strongly endorses the introduction of a binding minimum leverage ratio. The White Paper supports the Basel proposal of a 3% leverage ratio for all banks, including UK ring-fenced banks, and will continue to press for the implementation of the Basel standard through EU law.
Large ring fenced banks should hold a minimum amount of loss absorbing capacity - made up of equity or debt - of 17% of risk-weighted assets.
Their overseas operations should be exempt from this requirement unless they pose a risk to financial stability.
And for smaller UK banks, as the ICB recommends, the minimum requirements should be lower.
To deliver these proposals the authorities need a way to ‘bail in’ bank liabilities so bondholders, not taxpayers, bear the losses.
The Government will work with European partners to ensure that the ICB’s recommendations on bail-in are credibly and consistently applied across Europe, through the Recovery and Resolution Directive.
Mr Speaker, this Government intends to introduce the principle of Depositor Preference for insured deposits. Unsecured lenders to banks are better placed to monitor the risks that banks are taking on and they should take losses ahead of ordinary depositors.
Mr Speaker, our proposals on financial stability also improve competition in UK banking.
The implicit guarantee to large banks distorts competition; its reduction will help create a level playing field.
But Government wants to do more to encourage new entrants and promote competition.
We will shortly issue a consultation on reform to the payments system.
I welcome the reviews by the Bank of England and the FSA into the prudential and conduct requirements for new entrants to ensure that they are appropriate, not disproportionate.
And the Government strongly supports the need for a strong challenger bank to emerge from the Lloyds Banking Group divestment, and engaging with Lloyds and the European Commission to ensure that the divestment creates as strong a challenger as possible.
A more competitive market will only work if customers are prepared to change banks.
The Government is pleased with the progress on the industry led initiative to make current account switching faster and easier for customers. Providers covering 97% of the current account market have signed up and the scheme is on track to be launched next September.
But to switch, customers need better information so the Government welcomes the fact that the OFT and FCA will take forward the ICB’s recommendation to improve transparency across all retail banking products.
Work is already underway on a number of projects, such as making account data available to customers electronically to enable them to shop around.
Mr Speaker, financial stability is a pre-requisite for growth. Our analysis suggests that the proposals in the White Paper will cost, in GDP terms, in the region of £0.6 - £1.4bn per annum.
Compare that to the estimate that the 2007-2009 crisis has already cost the UK economy £140bn, one hundred times the maximum cost estimate.
So these proposals, while ambitious in scale, are proportionate in impact.
They will promote financial stability while supporting sustainable growth and maintaining the UK’s role as the world’s leading international financial centre.
Mr Speaker, the reforms we are announcing today, together with the changes we are making to the regulatory architecture, demonstrate that the Government is determined to take action to deliver a stable and sustainable banking system that underpins, rather than undermines, economic growth.