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Financial Services Bill

Second Reading

4.40 pm

The Chancellor of the Exchequer (Mr George Osborne): I beg to move, That the Bill be now read a Second time.

It is a pleasure to move Second Reading of the Bill. It is the product of many years of thinking, policy work in opposition, extensive consultation in government and impressive pre-legislative scrutiny in Parliament. I want to thank at the start the Joint Committee on the draft Financial Services Bill, which has made it a better piece of legislation, the Treasury Committee for challenging us to develop clearer lines of accountability in the Bill and the Treasury’s own Bill team, who have worked so hard for the past 20 months to produce the Bill before us.

The genesis of the Bill is obvious—the biggest failure of economic management and banking regulation in our country’s history. Its purpose is clear as well—to dismantle the disastrous tripartite system created 14 years ago and replace it with a structure of financial oversight that supports successful, competitive financial services while protecting the British taxpayer from the risk that those services run.

Of course, the Bill is not the complete answer to what went so spectacularly wrong. It should be seen alongside the Basel reforms to capital and liquidity, the living wills and resolution regimes that have been developed and the reforms to the structure of banking proposed by the Vickers commission. It is not by itself a sufficient response to the mistakes of the past, but it is absolutely necessary.

Let us remember what happened. Over the last decade before the crash, Britain experienced the biggest increase in debt of any major economy in the world. The total of household, corporate, financial and public sector debt in the UK reached a staggering 500% of gross domestic product. Our banks became the most leveraged in the world, and whether it was Northern Rock’s 120% mortgages secured on wholesale funding, Halifax Bank of Scotland’s catastrophic commercial property deals or the Royal Bank of Scotland’s reckless decision to buy ABN AMRO after the markets had frozen, such things did not attract the intervention or, it seemed, the concern of Britain’s tripartite regulatory system.

That system had been established as a by-product of the decision by the new Labour Government to give the Bank of England independent control of monetary policy. Without warning to the Bank, or anyone else, that institution was stripped of its historic responsibility for regulating the banking system, which was given to a new Financial Services Authority. It was a fateful decision, and one that we now know very nearly prompted the resignation of the then Governor of the Bank, the late Eddie George.

The comment 14 years ago by the Conservatives’ then shadow Chancellor, my right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley), during the passage of the Bank of England Bill, which created the tripartite system, was remarkably prescient. If he does not remember it, I will remind him of what he told the House. He warned that

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“with the removal of banking control to the Financial Services Authority…it is difficult to see how and whether the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse.”—[Official Report, 11 November 1997; Vol. 300, c. 731.]

He was spot on. However, at the time he and the Opposition whom he led through the Division Lobby were lone voices.

Fourteen years later, the general consensus is clear. There were fundamental flaws in the tripartite system right from the start, which are today painfully apparent to the whole world. The first and most serious flaw was that no one in the tripartite system saw it as their job to monitor risks across the whole financial system. The Bank of England focused increasingly on its monetary policy responsibilities; the FSA looked at individual firms, but was more focused on tick-box regulation of individual products than on the prudential health of whole businesses, let alone the financial system; and the Treasury took the fatal decision to run down its financial services division, turning the whole area into an under-resourced backwater in the Department.

The tripartite committee did not meet once in an entire decade, so no one was looking at the whole system or at the staggering build-up of debt in the economy and leverage in the banking system. As Lord Turner said in his review of the regulatory response to the banking crisis:

“The failure to do this analysis and to take action on it was one of the crucial failures of the years running up to the financial crisis.”

Claire Perry (Devizes) (Con): As my right hon. Friend is setting out what is essentially a political failure, will he enlighten the House on whether the report on one of the great victims of that failure—RBS—names any Members of Parliament as being specifically involved in the problem?

Mr Osborne: As my hon. Friend is aware—

Chris Bryant (Rhondda) (Lab): That’s why she asked.

Mr Osborne: Well, the report names Tony Blair, the right hon. Member for Kirkcaldy and Cowdenbeath (Mr Brown) and the shadow Chancellor. One of the interesting things is that the shadow Chancellor was, of course, instrumental, as I understand it, in creating the tripartite committee. We will hear in his response a detailed defence of the decisions he took.

Ed Balls (Morley and Outwood) (Lab/Co-op): Will the Chancellor share with the House the contents of the conversation I had with him in Downing street in December following the publication of that report and following my conversation with the chair of the FSA?

Mr Osborne: Why does the shadow Chancellor remind us of that?

Ed Balls: I shall repeat. Does the Chancellor recall the conversation we had in Downing street following my conversation with the chair of the FSA and will he tell the House of its contents?

Mr Osborne: It sounds like the right hon. Gentleman cannot remember it himself. No doubt he will use the time allotted to him to tell us about the role he played

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both as the adviser at the Treasury during the years when the system was created and as City Minister when the ABN AMRO deal was signed off, and about his role in the Cabinet when it decided on its response to those things.

Ed Balls: When I asked the chair of FSA, he said he could have inserted into the footnotes of that 400-page report any number of quotes from the Chancellor, who was at the time in opposition. Will he remind the House of any of his quotes from that period on the dangers of excessive regulation that could have been included in the FSA report?

Mr Osborne: First, the FSA report on RBS is worth reading and stands by itself. The chairman of the FSA chose to put the right hon. Gentleman’s name in it, which clearly irks him. Secondly, in opposition, we not only voted against the creation of the tripartite committee but consistently warned about growing debt in the economy—not just me, but my predecessors as shadow Chancellor. We will see tonight whether the Opposition vote against our proposed arrangements. We made those warnings; we are now proposing reforms to ensure that those sorts of things do not happen again.

Ed Balls: Perhaps the Chancellor should remind the House that the shadow Chancellor at the time also voted against Bank of England independence. In November 2006, the then shadow Financial Secretary, who is now Financial Secretary, said:

“Effective light-touch, risk-based and principles-based regulation is in the interests of the sector globally.”—[Official Report, 28 November 2006; Vol. 453, c. 995.]

Could that quote have been included in the FSA report?

Mr Osborne: I think the key word is “effective”, which is clearly what was lacking. If the right hon. Gentleman wants me to read out the legion of quotes that we have from him as City Minister, how about this one? He said:

“I believe that we are right to avoid prescriptive, heavy-handed regulation in Britain. Indeed, I believe that while it is Bank of England independence that is regularly cited as the Government’s most significant financial reform, the establishment of the FSA has been as important for Britain”,

and that

“It is important the FSA continues to deliver a light-touch and risk-based regulatory approach.”

We have ended up having a ding-dong across the Dispatch Box, but if he is against what we propose to do to change the system he created, will he vote against the Bill tonight?

Ed Balls: The Chancellor also said in June 2006 that this

“regulation has been burdensome, complex and makes cross-border market penetration more difficult.”

In June 2005, he said that

“we need to build our capacity to deliver world-beating goods and services, whether it is complex financial derivatives pioneered in the City of London”.

Are those quotes that could have been included in the FSA report? There are many more.

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Mr Osborne: This series of interventions is a little bit self-obsessed, and it reminds everyone of the right hon. Gentleman’s central role—

Ed Balls: You started it!

Mr Osborne: Well, that is a bit like the John Cleese sketch—the right hon. Gentleman started it by creating the biggest banking crisis in this country’s history. We are trying to clear it up. That is what this Bill is about. In all those interventions, we heard not one word about whether he will support what we are doing to clear up the mess he created.

Mr Edward Leigh (Gainsborough) (Con): Does not the ding-dong of the last four or five minutes illustrate the dangers of political interference in regulation? Once we get back to the subject of the Bank of England, and given that the top 1% of taxpayers provide 28% of total taxes, can we have regulation in the future less by populism on bonuses, salaries and the rest, and more by the raising of the right eyebrow of the Governor of the Bank of England?

Mr Osborne: The key issue in our regulatory system that we are seeking to restore is judgment by the regulator, and I will explain how the Bill will enable us to do that. I agree with my hon. Friend that the financial services are an incredibly important industry for this country. They employ more people than any other industry in Britain and, crucially, its proper regulation is not only good for the economy, but essential to prevent taxpayers from being exposed to what they have been exposed to in recent years.

Sir Peter Tapsell (Louth and Horncastle) (Con): As we are in the mood for recollection, and I am one of those who strongly opposed the tripartite system of supervision when it was introduced, may I say that I very much welcome the Bill? However, the whole strategic object of what we should be doing now is to ensure that we get rid of the shibboleth of the bank that is too big to fail. I doubt whether this admirable Bill, even combined with the Vickers report, will go anywhere near to restoring Glass-Steagall. We will not get rid of banks that are too big to fail until we get back to Glass-Steagall.

Mr Osborne: My right hon. Friend has been entirely consistent in the views he has expressed, and he was right all along about the weaknesses of the tripartite system. On the explicit issue of whether to introduce the actual physical separation of retail and investment banking—in other words, to introduce Glass-Steagall- like legislation in Britain—I asked John Vickers, who everyone accepts was an independent and extremely expert person for the job, to look specifically at this issue with his commissioners. Some of them were probably inclined at the start to believe that physical separation was the right way to go, but when they examined the issues—and they took an enormous amount of evidence—they believed that the same objective of protecting retail customers from the collapse of an investment bank, and giving the authorities of the day greater powers to protect retail customers as they resolved problems in a retail bank, could be achieved through the ring-fencing proposal that the Vickers commission put forward.

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That would also maintain some of the benefits of one part of the bank being able to support another part in trouble.

The commission explicitly considered the Glass-Steagall issue, but decided that ring-fencing was a better approach. We will introduce legislation that I hope and intend will have pre-legislative scrutiny in the House during the coming Session. I hope that that will be an opportunity for Parliament to examine the issue that my right hon. Friend rightly raised. As a country, we must decide once and for all how to proceed with the structure of our banking industry.

Charlie Elphicke (Dover) (Con): Will the Chancellor give way?

Mr Osborne: Yes, but then I should make some progress.

Charlie Elphicke: I hesitate to take the Chancellor back to the FSA report on the failure of RBS, which says that political pressures to be light-touch were partly to blame for the bank’s collapse. What exactly were those political pressures, in his understanding, and what lessons can be drawn from them?

Mr Osborne: My hon. Friend is tempting me back into the fertile territory of the shadow Chancellor’s role in the banking crash, but not least because I do not want to provoke a reaction, I think that I should probably move on to the flaws of the system that the right hon. Gentleman helped to create as Treasury adviser.

Ed Balls: Will the Chancellor give way?

Mr Osborne: Maybe we should just exchange our notes; then we could spare the House.

Andrew Bridgen (North West Leicestershire) (Con): To take the Chancellor back to my experiences in 1997, I was in business, and my bankers at the time were at the Royal Bank of Scotland. Shortly after the general election in which the Labour Government were elected, I had a meeting with my bankers. I expressed my disappointment at the election result, but they were extremely upbeat. I asked them why, and they said, “Labour Governments are never any good at regulating the financial services industry. We’re going to make a lot of money in the banking industry.” Were not those words prophetic?

Mr Osborne: For a while, they did make an awful lot of money. Unfortunately, they then lost an awful lot of money, which is one reason why we are here talking about the legislation.

Before any Minister comes to the House of Commons to ask for an existing regulatory regime to be replaced, it is incumbent on him or her to explain why it is felt to be necessary, so let me explain. Another flaw of the current system is that when the crisis hit in 2007 and 2008, no one knew who was actually in charge. The Treasury Committee of the last Parliament, led by John McFall, said in its report:

“The biggest failings of the Tripartite’s handling of Northern Rock were that it was not clear who was in charge, and, because the Tripartite took a minimalist view of their respective responsibilities, necessary actions fell between three stools.”

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The House of Lords Committee, which also did some excellent work on the matter during the last Parliament, said that

“the tripartite authorities in the United Kingdom…failed to maintain financial stability and were found wanting in dealing with the crisis, in part because the roles of the three parties were not well enough defined and it was not clear who was in charge”.

In other words, a whole system of financial regulation had been created by the previous Government, yet no one knew who was in charge.

That led to the third fatal flaw that became apparent. The Government of the day, accountable to Parliament and the public for the use of taxpayers’ money, simply did not have the powers to do what they felt necessary when the crisis hit. My predecessor as Chancellor said in his recent memoir:

“The whole system depended on the chairman of the FSA, the Governor of the Bank and the Chancellor seeing things in exactly the same way. The problem was that in September 2007, we simply did not see things in the same way.”

That, of course, led to the confusion in the autumn of 2007. As he said,

“I could not in practice order the Bank to do what I wanted”,

even when taxpayers’ money was at stake.

On top of all those flaws in the tripartite system, it is not as though customers were being better protected from the mis-selling scandals that have beset the industry for the past 30 years. The payment protection insurance saga happened on its watch. In 2001 alone, firms were forced to pay more than £1 billion-worth of redress to consumers who were mis-sold products.

Those are the flaws of the tripartite system—flaws that cost this country in output more than 10% of our entire gross domestic product, flaws that have led to hundreds of thousands of people losing their jobs, flaws that wiped out the savings of millions of small shareholders, and flaws that saddled an entire country with more than £1 trillion of debt. The British people need to be confident that mistakes have been acknowledged and that lessons have been learned. The legislation that we have put before the House today shows that they have been learned.

Ed Balls: Without wanting to disrupt too much the Chancellor’s political narrative, I ask him to remind the House of the regulatory structure and of who was in charge of regulation during the scandals involving the Bank of Credit and Commerce International, Barings, Equitable Life and Johnson Matthey. Were those scandals all the result of the tripartite structure, or might some of them have preceded it, at a time when the Bank of England had the lead on banking and financial regulation?

Mr Osborne: I would make this important point to the right hon. Gentleman: of course those were failures of regulation, and of course the Bank of England was in charge of banking regulation when they happened, but they were failures of regulation in individual firms—detailed work was done afterwards to find out what went wrong and to try to put it right—not failures across the system. The collapse of Barings did not bring down the whole system, whereas the run on Northern Rock created shockwaves around the world. The decision in 1997 to remove the Bank of England’s macro-prudential role was a fatal mistake.

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Ed Balls: Rubbish.

Mr Osborne: The right hon. Gentleman calls it rubbish, but let me say this: he was instrumental in a way that no one else in the Labour party was in designing the system that I am proposing to dismantle. He is well within his rights to get up and say, “I defend the system that I created. I think that it is the best way of regulating financial services, and what you have come up with is wrong”, but if he believes that, he should have the courage to vote against the Bill tonight. If that is his view, he should get up and say, “I’m going to vote against your approach because I don’t think it’s the right one”, but I do not think that he has the courage to do so, because he is trying to escape his past, rather than defend it.

Ed Balls: I will set out our position in my speech, but the idea that by making the Bank of England independent and adding a second deputy governor with responsibility for macro-prudential financial stability on both the Monetary Policy Committee and the FSA board, the Bank’s role in macro-prudential stability is diminished or removed is plain wrong. The Chancellor should not be allowed to state things that are outwith the facts.

Mr Osborne: The right hon. Gentleman is perfectly entitled to that view, but it is not shared by the Select Committees that have considered the matter, including during the previous Parliament; it is not a view shared in the work by the FSA on what went wrong and the failure to conduct macro-prudential analysis; and it is not a view shared by almost everyone who has looked at the failures of the British regulatory system during the period in question. He is perfectly entitled to his view—I am not surprised that he holds it, given that he was responsible for creating the system—but if it is his view, he should have the courage to vote against our proposals to dismantle it.

Claire Perry: Nor was the view of the right hon. Member for Morley and Outwood (Ed Balls) that of the Governor of the Bank of England, who said:

“All we can do at present…is to write our Financial Stability Report and give speeches.”

The Bank was completely emasculated by the right hon. Gentleman's reforms.

Mr Osborne: My hon. Friend reminds me that in the Mansion House speech in 2009, I think, the Governor, appointed by the previous Government, said that the Bank was being asked to do things that it had not been given the powers and tools to do. It was a striking speech—I cannot remember whether the right hon. Gentleman was there—but the difference between the views expressed by the Chancellor and the Bank Governor in the space of one evening was striking.

I will now go through the details of the Bill and see whether it commands all-party support. I shall go through what we are doing to address the flaws that I have identified in the existing system. First, we are going to establish a new macro-prudential authority in the Bank of England to monitor overall risk and levels of debt in the financial system. Secondly, we are making the Bank of England the single point of accountability for financial stability, ensuring that there is a decisive

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answer to the question, “Who is in charge?” Thirdly, the Bill ensures that in a crisis, when taxpayers’ money is at stake, the power to act sits with the Chancellor of the day, accountable to Parliament. Fourthly, the legislation creates a strong conduct regulator that is able to give its undivided attention to promoting competition and protecting consumers. Let me take each in turn, and in some detail.

First, the responsibility to monitor risks across the system falls to the new Financial Policy Committee in the Bank of England, established by clause 3 and entrusted with responsibility for the stability of the whole system. Its job will be to identify bubbles as they develop, spot dangerous interconnections, warn about poorly understood financial instruments and take action to stop excessive levels of debt building up before it is too late.

Jonathan Evans (Cardiff North) (Con): My right hon. Friend will be aware that the risks in the banking sector have been shown by the recent crisis to be rather different from those in the insurance sector, for instance. He will also know that the Joint Committee on the Bill recommended that a member of the Financial Policy Committee should be someone with insurance experience, but that does not appear in the Bill. Perhaps he could explain why not.

Mr Osborne: We do not want to prescribe in the Bill the qualifications of the external members of the Financial Policy Committee. That would be a mistake. However, I would obviously want to ensure that the external members—I will say something about this shortly—have broad and current experience of the financial system. There is an issue, as I will set out, about how this House—and, indeed, the political system—approaches conflicts of interest. In other words, we have to make a trade-off between appointing as external members to such bodies people who actually know what is going on in financial services and, at the same time, wanting to direct conflicts of interest, being careful not to rule out anyone simply because they work in financial services. The Select Committee on the Treasury and the Joint Committee that looked at the Bill have made an important recommendation for us all: to be careful about creating a system in which no one who has current experience of financial services sits on the bodies that regulate individual firms or, more importantly, system-wide risks, and that includes insurance.

Charlie Elphicke: With the tripartite system, of which I believe the shadow Chancellor was the architect, a tick-box culture of regulation grew—a one-size-fits-all approach, and that sort of thing. Will the Chancellor tell the House a bit about how we will get rid of that tick-box culture and move towards a culture of more individual and tailored regulation?

Mr Osborne: The key thing is to empower the regulators both to exercise judgment and then to be able to do something about it. One reason for locating both the macro-prudential role and, when it comes to individual firms, the micro-prudential role in the central bank is the culture in central banks—not just in the Bank of England, but in central banks generally—of exercising judgment and acting on it. I very much want to encourage that. My hon. Friend is right: there was no shortage of regulation, in that sense, in 2006-07. RBS complied

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with every bit of regulation in its decision to try to take over ABN AMRO; it is just that no one felt empowered to say, “Is this the right thing, for this firm and for the financial system, at a point when the financial markets have already frozen up?”

Rather than wait for this Bill to pass through Parliament, we have gone ahead and created the Financial Policy Committee on an interim and non-statutory basis. It is already meeting regularly to assess risks across the financial system, such as the need for banks to provide for adequate capital before determining the distribution of profits, as well as drawing attention to specific products, such as exchange-traded funds, whose excessive use may be a cause for concern. It has already produced two impressive financial stability reports.

Kerry McCarthy (Bristol East) (Lab): At the time of the collapse of Barings, I was working at Abbey National Treasury, which was involved in a joint venture trading derivatives with Barings. I was one of those brought in to clear up the mess, for which—I hasten to add—I was not responsible.

It was clear from what happened at Barings that there was a huge gulf between what the traders understood about their trading activities and what the management understood, and an even bigger gulf between the management and the regulators at the Bank of England. The Chancellor has said that the new committee will look at exotic and complex financial instruments, but how can he guarantee that its members will really understand what is happening on the trading floor?

Mr Osborne: That is the task that we are giving them. They must ensure that they have the necessary expertise and resources. The interim committee is looking across the piece—I will deal later with the role of regulating individual firms—but it is interesting that its two financial stability reports highlighted a specific financial instrument, the exchange-traded fund, and expressed concern about its rapid growth. I am not aware that the regulatory system that existed in 2006-07 spotted, for example, the rapid increase in the use of collateralised debt obligations. It did not warn about specific instruments and the growth in their use. The financial stability reports of the committee that we have already set up demonstrate an attention to particular complex market instruments and their potential systemic risks.

Ed Balls: Will the Chancellor explain why, if the key is locating regulation in the central bank, those pressures before 2007 were not spotted by the US Federal Reserve, which was the central banker and the regulator? He is giving a very UK-specific analysis. What about all the other examples of central banks failing to spot these growing problems?

Mr Osborne: There are examples of central banks, such as the Canadian and Spanish central banks, which were much more aggressive in counter-cyclical regulation, and which felt empowered to make the decisions. In the United States—I am sure that the right hon. Gentleman has had conversations about this with the United States Treasury Secretary and the Federal Reserve chairman—things have been taken to the opposite extreme. There is

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a plethora of regulators—too many different regulators. The single biggest problem in the United States probably occurred in the insurance industry, in the American International Group. There was an insurance regulator based in one particular state and it was not something for which the Federal Reserve had a responsibility. Ben Bernanke has talked about the role of central banks, and I shall say something about his view later.

I think it right for us to create a Financial Policy Committee that is on a statutory footing. I have talked about the importance of its having external independent members who are able to provide market expertise and challenge received opinion, but I believe—and this may be something that we can tease out in Committee—that we should think about how we can get the balance right, and avoid conflicts of interest while also bringing in people with real expertise.

What makes the Financial Policy Committee that the Bill will establish such a radical departure in terms of policy making is that we are not only asking it to assess the risks throughout the financial system, but proposing to give it powerful tools with which to do something about those risks. The Monetary Policy Committee assesses the risks of inflation and whether it will overshoot or undershoot the target, and then alters interest rates as appropriate. The Financial Policy Committee will be given macro-prudential tools with which to hit the financial stability objectives set out in the Bill, and to reduce and remove systemic risks to the stability and resilience of the UK financial system.

Sir Peter Tapsell: The shadow Chancellor raised the question of both Barings and BCCI, and it underlines the nature of the regulatory problem. The Barings failure was largely a failure of the Singapore regulatory authority. I was closely involved with Singapore as an adviser to the monetary authority at the time. The Government in Singapore were horrified by the fact that a British rogue trader had not been spotted, but it was the responsibility of Singapore to find him.

As for BCCI, which I also knew well in my stockbroking days, its regulator was in Luxembourg, which was the reason why the Bank of England did not spot the problem until too late. That problem will continue. There are considerable limits to what any regulator can ever achieve. In worldwide banking, there will always be people overseas who are up to mischief, and no regulator based in London can ever conceivably know what they are all up to.

Mr Osborne: My right hon. Friend makes a very good point about the international nature of this business. We must try to design a regulatory system that protects the British taxpayer from rogue traders and illegal activity in individual firms that might create broader systemic risks. We must also be alert to broader risks building up in the system—for example, when trying to moderate the impact of a credit boom. This is not just a question of dealing with individual risks and individual firms; it is also a question of dealing with risks across the financial system.

My right hon. Friend is completely right to draw our attention to the need for regulators to work together better internationally. The least well-developed piece of the financial regulatory system, post-crash—the one lesson that has not yet been taken far enough—involves

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the way in which we can better protect the world from large international businesses that live internationally but die nationally, such as Lehman Brothers. Co-ordinating resolution regimes across the different jurisdictions will be the work of international bodies such as the G20 and the Financial Stability Board in the year ahead.

Stephen Gilbert (St Austell and Newquay) (LD): My right hon. Friend has talked about the macro-prudential powers that the Bank of England will have, beyond its monetary policy powers, to step in and help to cool down the economy. Those powers will include setting the ratio for the multiples of earnings that can be borrowed to secure a mortgage, which could have serious consequences across the country. However, those regimes have not yet been published or discussed. Can he give me an assurance that, when those macro-prudential powers are published, the House will have a debate on them?

Mr Osborne: Yes, I can give that assurance. This is an important point that I want to flag up so that the House understands what we are collectively embarking on. We are seeking to give the Financial Policy Committee the tools to help to dampen down a credit boom or to help in a credit crunch. As my hon. Friend has said, it will be able to alter the maximum loan-to-value ratios in mortgage lending in order to curb an unsustainable rise in house prices. It will also be able to do the reverse, should we face unwanted house price deflation. It will also, potentially, be able to alter capital requirements for banks, in a counter-cyclical way. I should say that these are just possibilities; they are potential tools that the committee might want to use.

One key feature is that the measures will be independently applied, so there will be no political pressure to, say, keep a housing boom stoked up as an election approaches. Another key feature is that the Financial Policy Committee should act symmetrically—that is the intention of Parliament. Its job will be to act not just to moderate a credit boom but to try to alleviate a credit bust. The precise tools that we give the FPC have yet to be determined, as my hon. Friend has just said. We have sought the advice of the interim organisation that we have created, and it will come to us with proposals for the kind of tools that the permanent body will need. We will then seek the approval of both houses of Parliament through the affirmative resolution procedure—which will of course involve a debate—before we pass those tools over.

I freely accept that we are in largely uncharted policy- making territory, here or anywhere in the world. Many other jurisdictions are considering such measures, but we are ahead of most of them. Surely the experiment of making no attempt to moderate the credit cycle—letting the bubbles grow and burst, then cleaning up afterwards—has been an unmitigated disaster, and we would be failing if we did not look for an alternative approach.

Mr George Mudie (Leeds East) (Lab): One suggestion from the Treasury Select Committee was that the Chancellor should not send the proposals to a statutory instrument Committee. That would involve a 90-minute discussion and the proposals would not be amendable. He should instead allow the matters to be debated seriously on the Floor of the House. I wonder why he would think it

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attractive and helpful to send them upstairs where they cannot be amended; that would suggest a foregone conclusion by the governing party that they would be accepted.

Mr Osborne: I would certainly be happy to have a debate about that on the Floor of the House. It is a decision for my colleagues, the usual channels and so forth, but in my opinion the important tools given to this body will have a real impact on our constituents. It will affect the kind of house they are able to afford on their income—the bread and butter of people’s daily lives—and it is important for us all to understand that as we create instruments of policy.

We are seeking to address another flaw in the system by making the Bank of England the single point of accountability when it comes to the prudential regulation of banks, large and complex investment firms, building societies and, as my hon. Friend the Member for Cardiff North (Jonathan Evans) reminded us, significant insurance companies. A new prudential regulation authority will be established within the Bank to perform that major new function.

As the shadow Chancellor pointed out, the Federal Reserve in the US already has responsibility for the prudential regulation of major banks, but not of other financial firms. Let me cite what Ben Bernanke said in what I believe was testimony before Congress:

“The Federal Reserve’s role in banking supervision complements its other responsibilities, especially its role in managing financial crises...During the current crisis, supervisory expertise and information have repeatedly proved invaluable in helping us to address potential systemic risks involving specific financial institutions and markets and to effectively fulfil our role as lender of last resort...The Fed’s prudential supervision benefits, in turn, from the expertise we develop in carrying out other parts of our mission—for example, the knowledge of financial and economic conditions we gather in the formulation of monetary policy.”

I raise this matter because at the heart of the new arrangements we are seeking to establish an understanding that today’s financial markets are so interconnected that the failure of a single firm can bring down the whole system, and risks across the system can bring down many single firms. These feedback loops are what proved so devastating in the crisis.

Some critics of the legislation now accept the need for a macro-prudential Financial Policy Committee, but still doubt whether we should give the Bank responsibility for the micro-prudential regulation of individual firms, too. I would argue that because the interconnections are so great, the FPC could not do its job without knowing what is going on in firms, and a prudential regulator could not do its job without knowing about risks across the system. The best way to combine the insights is to put them both under the aegis of the same institution—the central bank.

I understand that the shadow Chancellor is concerned that our Bill does not create additional lines of communication between the deputy governors of the Bank and the Chancellor, bypassing the Governor, so he might like to explain what he meant. I considered the idea, but rejected it. I think we need to force the Bank of England itself to reconcile its internal differences rather than create additional lines of accountability between the Chancellor and a deputy governor. Perhaps the right hon. Gentleman—[Interruption.] He says,

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“Dear me”, so perhaps he will explain why he wants to institutionalise a regime in which the No. 2 constantly undermines the No. 1.

The Joint Committee and the Treasury Select Committee have raised what I regard as a far more relevant concern—the accountability of the Bank of England, given its important new responsibilities. We have listened carefully to the recommendations from both Committees and while I do not propose to abolish the court of the Bank of England, I do propose to give it important new powers to hold the executive Bank to account. The Governor and the court of the Bank of England have agreed that a new oversight committee, consisting of the non-executive members of the court, should be created. This group of external independent people will ensure that the Bank discharges its financial oversight responsibilities correctly; it will be able to commission both internal and external reports on the Bank’s policy makers’ handling of particular events and particular periods of policy making. Those reports will be published, with market-sensitive information protected, if necessary.

The Governor is of course, as is the case today, a key figure in the arrangements. It is important that he or she is not only independent of the Government of the day, but seen to be so. The recent experience of reappointing Governors after their first five-year term has expired has not been a very happy one. It has created unnecessary uncertainty and called into question political confidence in the Governor. Although I would hope that this Government would handle the whole thing better than their predecessors did, it makes sense simply to eliminate the possibility of discord entirely, so schedule 2 provides that the next Governor of the Bank of England and his or her successors will serve a single eight-year non-renewable term. That is a sensible reform.

The third flaw in the current arrangements was the fact that the Chancellor of the day felt he did not have the necessary powers to act in the interests of taxpayers. This is another area where the work of the Joint Committee and the Select Committee have proved invaluable. The Bill makes it clear that the day-to-day responsibility for financial stability lies with the Bank of England. We do not want the Treasury second-guessing that work. Beyond setting the parameters for the regulatory system, the Chancellor should become involved only if there is a material risk to public funds. The responsibility in this regard is made clear in the Bill, and in the memorandum of understanding that we have drawn up with the Bank. The Bill makes it clear that the Governor has a responsibility to inform the Treasury immediately as soon as there is a material risk of circumstances arising in which public funds might reasonably be expected to be used.

The Bill is also rightly clear that the use of public funds is entirely a decision for the Chancellor, as he or she is the person accountable to Parliament, and through Parliament to the public. My predecessor is, again, revealing about the limitations of the current arrangements in his book:

“My frustration was that I could not in practice order the Bank to do what I wanted. Only the Bank of England can put the necessary funds into the banking system…I asked Treasury officials if there was a way of forcing the Governor’s hand. The fact that we had given the Bank independence had a downside as well as an upside.”

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Of course my predecessor had, as any Chancellor does, the general power of direction over the Bank that the Bank of England Act 1946 provides, but that general power of direction has never been used, so it is a nuclear option that might blow up anyone who tries to use it. That was the conclusion that my predecessor reluctantly came to.

That is unsatisfactory. The Bank must, of course, be protected from politicians who want to use its balance sheet against the wishes of the Governor simply because those politicians want to avoid using the Government’s balance sheet, but the Bank should not be able to use that as an excuse to withhold its services as an agent from a Government prepared to use its own Government balance sheet. Otherwise, in many situations that becomes, in effect, a veto on an elected Government’s fiscal decision making.

The Bill and the memorandum of understanding give the Chancellor of the day not only the right to be informed when there is a material risk to public funds, but the right to ask the Bank to analyse different options that might be available to deal with the risk, and in the newly added clause 57 the Bill gives the Chancellor a defined power of direction to require the Bank to provide liquidity to a particular firm or to put a particular firm into resolution or to provide liquidity to the general system, provided that the Chancellor does so using the Government’s own balance sheet, and makes that clear.

Ed Balls: Can the Chancellor envisage a situation in which the Governor of the Bank of England may judge not to inform the Chancellor that there is both a material threat to stability and the need for the use of public funds—and if a Governor were to make such a judgment not to inform the Chancellor, would that be his personal judgment?

Mr Osborne: First, the Bank Governor will have a statutory obligation to inform the Chancellor, so they would be failing in their statutory obligations—

Ed Balls rose—

Mr Osborne: Perhaps I have misunderstood the question.

Ed Balls: This is important, so I will ask the question again. Can the Chancellor envisage a situation in which the Governor of the Bank of England would choose not to inform the Chancellor because in the Governor’s view there was not a material threat to financial stability, and therefore no need for the use of public funds? And if the Governor chose not to come to the Chancellor in such a situation, would that be the Governor’s own personal judgment—for example, if the deputy governor for financial stability or the head of the Prudential Regulation Authority took a different view?

Mr Osborne: The legislation makes it clear that that is the Bank’s responsibility. Of course, the Governor is chair of the key committees—the Financial Policy Committee and the Prudential Regulation Authority—that would make these judgments, but we have to require the Bank to resolve its internal differences. Obviously the Bank has its own procedures to deal with any dispute, which it will develop, but we have deliberately created

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boards and committees that have independent members and external oversight. Of course there are three deputy governors, but ultimately—perhaps that is just going to be a point of disagreement between me and the right hon. Gentleman—I do not think it is right to create different lines of accountability from the Bank of England to the Chancellor of the day. The Chancellor has to deal with the Bank, and with the person of the Governor. However much legislation we write and however many clauses we put in place, those who do my job and that of the Governor also have a very important responsibility to get on with each other and to try to make that arrangement work.

Ed Balls: The problem is that in the legislation, in the memorandum of understanding and in the Chancellor’s own answers there is a gap, a hole and an ambiguity. In his speech he referred to the judgment of the Governor, then he talks about the judgment of the Bank and then he says that the Bank must resolve whether the Governor’s view is the same as that of the rest of the Bank. I repeat my question: can the right hon. Gentleman envisage being concerned by a situation in which the Governor chooses not to come to him asking for funds because the Governor believes that there is not a systemic risk, even if it is coming to the Chancellor’s attention that other senior statutory office holders in the Bank have a different view? Can the right hon. Gentleman envisage such a situation, when the Governor chooses, for example —as he said, this is a judgment for the Governor—that the moral hazard overrides the systemic potential threat?

Mr Osborne: As I say, it is the responsibility of the Bank to inform the Government: that is what the legislation and the memorandum of understanding make clear. The Bank, of course, has its own procedures for coming to a view within the Bank. Creating a system where a deputy governor could bypass the Governor and go directly to the Chancellor would be a recipe for division at the Bank. We have to force the Bank to come to a collective view and then deal with the Government of the day.

Ed Balls: This goes absolutely to the heart of the issue. The reality is that if we have a tripartite or quartet system in which the statutory regulator is not the same as the Governor, the head of the PRA or the head of the Financial Services Authority can have a different view and say that in their judgment the threat to the company and to the system is so great that it justifies action, even if the Governor judges that the moral hazard risks from intervention override that threat, and that therefore there should not be a request for public funds. In the current system, the Chancellor would hear from the head of the FSA—from Adair Turner—whereas under the new system and the memorandum of understanding he will not hear, other than from the person of the Governor. My question to the Chancellor is: does he worry about that and about the potential instability and misinformation to him that could come as a result of the memorandum of understanding that he has drafted?

Mr Osborne: The first point I make to the right hon. Gentleman is that the Bank Governor does not come to the Government when he thinks public funds should be used; he does so when—this is set out in the legislation—

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there is a material risk that public funds may be required. Of course the decision to use public funds would be one for the Chancellor of the day.

The second point that I make is that the problem with the tripartite committee was one set out in my predecessor’s book: in autumn 2007 there were three different views and there was no way of reconciling them—and there was no clarity about who had power and responsibility. What we are talking about here, and what I am explaining, is a new power of direction. Of course any Chancellor would think very carefully before using it, but this power makes it absolutely clear that once there is a material risk to public funds, the Chancellor of the Exchequer has not only a power, as the current person doing the Chancellor’s job has, to authorise the use of public funds—that is what my predecessor did in respect of the Royal Bank of Scotland—but a power of direction to provide liquidity to an individual firm and liquidity to the system. Those were not powers that my predecessor had. Of course, as I will come on to discuss, there are certain constraints and things that have to be done to inform people before they are used, but these are new powers that we are giving so that the Chancellor of the day does have powers, provided that he or she is prepared to use the Government’s own balance sheet.

Ed Balls rose

Mr Osborne: I will give way one final time, but then I will conclude.

Ed Balls: The whole point—this is so important, and goes to the heart of one of the debates in the Committee—is that in the historical examples given by the Chancellor, when the then Chancellor wanted to act and others in the regulatory system did not, the Governor of the Bank of England was one of those who did not. In the situation that the Chancellor has now set up—article 20 of the memorandum of understanding states this clearly—there will be a personal relationship between the Chancellor and the Governor. This ‘twin-peaks’ system is a personalised conversation, in that the Chancellor hears the Bank’s view from only one individual. I ask him again: would he be worried if he did not hear a view in such circumstances? Is this really a matter for the Governor’s judgment, as the MOU says, or should the statutory office holders—the head of the Prudential Regulation Authority, the Financial Services Authority and the deputy governor from the Financial Policy Committee—have not only a view but a right for that view to be heard by the Chancellor and then by Parliament? That is my question.

Mr Osborne: We can explore this at greater length in Committee, but I say to the right hon. Gentleman now that we are trying to avoid a situation in which different people in the Bank think they have a direct line to the Chancellor. We are trying to require the Bank to resolve its internal differences, and we are creating various committees, balancing the membership between external and internal members, but we absolutely see a central role for the Governor of the Bank—and I do not make any apologies for that.

I was not in the room when some of these conversations happened in recent years, but as far as I can see, and as has been reported since, it is clear that personal relations between the Bank Governor and some of the very

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senior members of the Government completely broke down. That is not a situation we want to see in the future, and I think that the person who does my job and the person who does the job of the Governor of the Bank of England have an obligation to get on with each other and maintain the personal relationship; that is a very important part of both our jobs. No amount of legislation or MOU—




The right hon. Member for Morley and Outwood (Ed Balls) says that it is not about getting on with each other. Frankly, it is about working at this very important relationship at the top of our financial system, and not getting into a situation in which those involved are not able to pick up the phone and talk to each other. Yes, of course we are institutionalising the arrangement, creating memorandums of understanding and so on, but I do not want to detract from the fact that there is also a personal responsibility for the Chancellor of the day and for the Bank of England Governor to ensure that they can work together in the national interest.

Mr Geoffrey Robinson (Coventry North West) (Lab): I hate to intrude on this Socratic dialogue between the Chancellor and my right hon. Friend the Member for Morley and Outwood (Ed Balls), but can the Chancellor not see that in these critical decisions there will be differences? I do not draw a direct comparison with the military, where the Chief of the Defence Staff has a right of appeal or a direct line of communication with the Prime Minister, but in these critical decisions it is not enough for a hard-headed, narrow-minded or too-forceful Government to insist on a point of view. A release valve is needed to reach a balanced judgment, and the No. 2s in all the crucial areas should have the right to come straight to the Chancellor. Good foresight and good judgment are involved in that.

Mr Osborne: The other point that I would make—the Financial Secretary to the Treasury is reminding me of it—is that the Treasury sits on all those committees as a non-voting member. It is in on all the discussions, with a Treasury official sitting in on and understanding the debate.

Several hon. Members rose

Mr Osborne: I give way to my hon. Friend the Member for West Suffolk (Matthew Hancock), who has worked in the Bank of England.

Matthew Hancock (West Suffolk) (Con): Does the Opposition’s proposal not seem to be an attempt to re-create a tripartite structure in which there is more than a relationship between one and one other? We have problems with the concept of “too big to fail”, and the example of Barings has been cited. That bank did not bring the rest of the system down: the directors ended up losing their jobs and the person responsible went to prison. Will the Chancellor consider the scale of that failure, compared with what happened in 2008 when the whole system collapsed?

Mr Osborne: My hon. Friend is absolutely right. There was a failure of regulation with Barings, but the collapse of Barings did not bring down the financial system, either in the City of London or more broadly.

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Mark Field (Cities of London and Westminster) (Con): My right hon. Friend is absolutely right about this. Surely the issue is the clarity of the relationship between the Governor and the Chancellor of the Exchequer in relation to the confusion in the tripartite system. That would not prevent, and should not prevent, any Governor worth his salt from at least making it clear that there were other views within the Bank, albeit that it was his judgment in the advice to the Chancellor. That gets away from some of the confusion about whether we are looking to sweep away an integral part of the tripartite system.

Mr Osborne: My hon. Friend makes an extremely good point. This is all about the Governor’s responsibility to do his or her job in managing the Bank, and about the Bank coming to a collective view. The job of the Chancellor of the day is to manage the relationship with the Governor. For all the virtues of the tripartite system that the shadow Chancellor seems to be extolling, I understand that those at the principal level in the tripartite system did not meet for 10 years; perhaps he can correct me, as he was there.

Ed Balls: The tripartite standing committee met every month at the deputy level, from its inception until the crisis. The responsibility for triggering a full meeting of principals was in the hands of the Governor and the head of the FSA. Throughout that entire period either the systemic regulator, the Bank, or the individual firms regulator, the FSA, could have triggered a meeting, but did not. There were two people who could have triggered that, but in the Chancellor’s world there will be only one trigger. That is my concern.

Mr Osborne: The right hon. Gentleman keeps saying there were two people, but there were three principals in the tripartite committee. It was chaired by the Chancellor of the day—the Chancellor whom he advised—but as I understand it, that Chancellor never convened the tripartite regime at the principal level. [ Interruption. ] I can tell the shadow Chancellor that under the tripartite regime now—that is still the current arrangement—there are meetings on at least a monthly basis with myself, the Governor of the Bank, the chairman of the FSA and so on. In the tripartite system that the shadow Chancellor saw at first hand, the principals, including the Chancellor of the day, never in 10 years—we are not talking about 10 weeks or 10 months—convened a meeting of the principals. The fact that he says that it was entirely the job of the Governor of the Bank of England or the chairman of the FSA to call a meeting, when the chair was the Chancellor, who could have called a meeting at any time he wanted, is very revealing about what went wrong.

Mark Durkan (Foyle) (SDLP): Is the power to direct, to which the Chancellor has referred, contingent on the Governor of the Bank of England formally advising the Chancellor of a material risk, or could the Chancellor exercise that power to direct on the basis of his own concerns, which may have been conveyed to him from the industry, Parliament or any other intelligence? The Bank might be loth to advise the Chancellor formally in that way if doing so would trigger the power to direct, because it might want to avoid that, and the wider concerns that it might raise. Once the Bank has had the

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“Shall we tell the Chancellor?” discussion, what should the Treasury representative do during that discussion and after it?

Mr Osborne: As I have said, when the Bill is passed, the statutory responsibility will be on the Bank of England to inform the Government if there is a material risk that public funds might be used. We are trying to get away from a system in which it is the Treasury’s responsibility to try to regulate the financial system on a day-to-day basis in peacetime. We are giving the responsibility and clear accountability to the Bank of England so that it will trigger the arrangement by informing us of a material risk. As is set out in the legislation, twice-yearly meetings between the Chancellor and the Governor to discuss these things are required, although there could also be further meetings. Once the Bank has informed the Treasury of a material risk, which it will have a statutory responsibility to do, there will be a power of direction. I should just say, for the sake of completeness, that if we wish to keep the details of the use of this power confidential, I or my successors would have to inform, on a confidential basis, the Chairs of the Treasury Committee and the Public Accounts Committee, so that representatives of Parliament were informed.

The fourth and final flaw in the system that we are trying to address is that customers and consumers too often get a raw deal from the regulation of financial services. The disappearance from the high street of names such as HBOS and Bradford & Bingley has inevitably reduced competition in an industry that was becoming more and more consolidated even before the crash. The existing regulator’s dual prudential and consumer remit means that it cannot give consumer interests its undivided attention. In response to the Vickers commission and the Joint Committee, the new authority will have an explicit responsibility to promote competition. We have listened to the Joint Committee and announced that we will also bring the regulation of consumer credit into the authority’s remit so that, for the first time, the regulation of all retail financial services will be under one roof, and things like payday loans will be subject to tougher regulation.

Stella Creasy (Walthamstow) (Lab/Co-op): The banks that have gone from my high street have been replaced by high-cost credit companies that offer exorbitant rates of interest. I know that the Financial Conduct Authority will have powers over competition. Does the Chancellor accept the argument, made by many Opposition Members, that price inevitably reflects competition, so it is absolutely right that the FCA should look to regulate the price of those products and finally tackle the legal loan sharks?

Mr Osborne: The Department for Business, Innovation and Skills has commissioned a review of the cost of credit, but I think that the Bill takes a significant step on that, partly because of the Joint Committee’s recommendations, because the regulation of all retail financial services will now come under the remit of the FCA. It will have the power to ban specific products, to name and shame particular firms and to publish details of misleading promotions, so there will be considerable new powers that were not previously available. On the hon. Lady’s specific concern about the price of credit,

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that is something the Government are looking at. Of course we are also looking at the recommendations of the FSA’s recent report on RBS—I do not wish to reopen that issue—in relation to legislation on the sanctions available for bank directors who fail in their role.

The Bill is an important piece of legislation. I believe that it replaces the confused and dysfunctional system that presided over the biggest banking crisis in our modern history. It creates clear lines of accountability by putting the Bank of England in charge of monitoring and dealing with debt levels in our economy. However, no amount of new clauses, powers or institutions can substitute for something for which Parliament cannot legislate: judgment. There were thousands of pages of financial regulation in existence in 2007, but that did not stop the queues forming outside Northern Rock or prevent RBS from making its final, fatal, bid for ABN AMRO. I hope that we have learned that financial stability depends not simply on a checklist of regulation, but on individuals within our regulators feeling empowered to trust their judgment, and our giving them the power to act on it. By putting our central bank in charge of monitoring overall levels of risk and the soundness of individual firms, we are trusting in its judgment. By giving the elected Government of the day the power of direction in a crisis, we are trusting in their judgment, and that of Parliament, to which they are accountable.

Britain has paid a higher price than most for what went so badly wrong in our banking system. The errors of the economic policy that led to such a boom have cost every taxpayer dear. Today we show that we are learning the lessons and passing on to our successors a better system than the one we inherited. I commend the Bill to the House.

Several hon. Members rose

Mr Deputy Speaker (Mr Nigel Evans): Order. Before calling the shadow Chancellor, I indicate to hon. Members who wish to take part in the debate that there will be a 10-minute time limit on Back-Bench contributions, with the usual procedure for interventions.

5.48 pm

Ed Balls (Morley and Outwood) (Lab/Co-op): Let me start by striking a rather different tone from that of the Chancellor’s performance in the House this afternoon by setting out where the Opposition agree with what he and the Government are trying to achieve and offering some constructive proposals to tackle the flaws in the legislation before us and help make it a better Bill. Financial stability and the effective regulation of our banking and wider financial services industry are vital for stability, for consumers to save and for businesses to invest. Getting the balance of regulation right is an important task for any Government, especially when hundreds of thousands of jobs depend on the industry. That is a task in which all Governments throughout the world failed during the previous decade.

We can all agree that the irresponsible actions of the banks themselves caused the crisis, but there were major failings in financial regulation, in law, in corporate governance, in procedure and in judgment in America, Asia, throughout Europe and here, too, in Britain. We did not regulate the banks in a tough enough way and stop their gross irresponsibility here in Britain or throughout

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the world, and after a financial crisis on that global scale we need to learn the right lessons and to put in place the right reforms in order to do what we can to stop such a crisis being repeated.

In that spirit, we welcome aspects of the Bill before us and, in particular, the establishment of the new Financial Policy Committee and the competition and consumer focus of the Financial Conduct Authority, but we are worried that the Bill falls well short of being fit for purpose.

In an excellent report, the Joint Committee that scrutinised the draft Bill stated:

“To be successful reforms will have to change the regulatory culture and philosophy,”

which is

“not something that legislation can guarantee but legislation can influence the culture of a regulator by: setting objectives; allocating and aligning powers and responsibilities; establishing appropriate systems of accountability.”

Despite the changes that the Government made in response to the Joint Committee’s report, the Bill as it stands does not meet the objectives that the Committee set. What the Chancellor proposes in the Bill and in statute is essentially to move from the current tripartite system of regulation to a new quartet system—the Treasury, the Financial Policy Committee, the Prudential Regulation Authority and the Financial Conduct Authority, with the Monetary Policy Committee sitting alongside—with, at best, opaque structures for decision making and accountability under the Bank of England umbrella, albeit now with not two deputy governors but three, and all with overlapping responsibilities.

Unless we get the detail of that quartet system right, we risk delivering a more complex and less transparent system that is harder for the Chancellor and for Parliament to navigate and understand than the current arrangements. Several of those substantial misgivings have been echoed in recent weeks and days by the Treasury Committee and by many City, business and consumer groups. The responsibilities are confused; there is insufficient accountability in the new, more cumbersome system; there is insufficient focus on consumer protection, financial education and exclusion; and, as the CBI has highlighted, there is no objective for the Financial Policy Committee proactively to support growth and employment.

We intend to work with the Government and the Treasury Committee to amend the Bill in Committee to deal with its many shortcomings. To that end, we will not vote in opposition to the Bill in its entirety on Second Reading today; we will see whether we can make progress in Committee and then decide our Third Reading vote only when we have seen whether we have been able to make the progress and the change that is needed in the Bill.

Kelvin Hopkins (Luton North) (Lab): Does my right hon. Friend accept that the crisis was caused in very large part by a complete failure of the auditing industry? If the auditors of all those companies and banks had spotted that worthless bits of paper, claimed as assets, were flooding the world, we might not be where we are now. Does he agree that we need to do something fundamental about auditing?

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Ed Balls: There were failures in auditing, in corporate governance, in regulation—

Sajid Javid (Bromsgrove) (Con): In government.

Ed Balls: In Government regulation, in credit rating agencies and in Governments throughout the world. I shall come to some of the wider failures in a moment.

Charlie Elphicke rose

Ed Balls: But I will take another intervention. Let us hope that this one is better.

Charlie Elphicke: Does the shadow Chancellor accept that it was a failure of regulation when, to buy a home, people were lent more money than that home was worth? Was it not wrong to have mortgages of more than 100%, and was that not a failure of regulation?

Ed Balls: The problem was the US sub-prime mortgage market, and that the failure of regulation there rippled around the world. There were failures also of lending and regulation at Northern Rock here in Britain. I do not in any way deny that there were failures here in Britain and failures of regulation, but I do not accept that it was solely a UK failure, because it happened in America, France, Germany, Japan and all around—

Harriett Baldwin (West Worcestershire) (Con) rose

Gordon Birtwistle (Burnley) (LD) rose

Ed Balls: I will make some progress and take both interventions in a minute.

I understand why politically the Chancellor is so keen to blame the structure of UK regulation—the tripartite relationship between the Bank, the Treasury and the FSA. He wants to claim that his particular institutional reforms are the solution, but my advice to him is to be very careful indeed, because this was not a peculiarly British crisis; it was a global crisis. It hit countries with tripartite systems of regulation, quartet systems, twin peaks, more powerful central banks, less powerful central banks and statutory and non-statutory regulators alike, and it was not a failure of regulatory structure, but a collective global failure to see the risks inherent in the structure of the global financial services industry.

We heard from central bankers earlier, but Alan Greenspan, the former chair of the US Federal Reserve and architect of the US system, when asked by The New York Times about his and the world’s understanding and management of risk, said:

“The whole intellectual edifice…collapsed”.

He was right. It was not simply a failure of structure, but a flaw in the way regulators understood the financial system, and that is why the British Bankers Association is right in its submission on the Bill to say that

“we consider that successful regulation depends more on regulatory culture, focus and philosophy than structure.”

Harriett Baldwin: On that very point, I should like to understand where the right hon. Gentleman is coming from in his objections to the Bill. What was his philosophy

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in terms of separating the supervision of banks from the Bank of England, which has day-to-day responsibility for monitoring that canary in the goldmine—their day-to-day funding operations?

Ed Balls: I am going to come on to explain my analysis. I am not sure I fully understood the question, but I might as time passes.

At its heart, the regulatory failure of the global financial crisis was not a failure of one approach to the institutions of regulation, but a failure of understanding and risk assessment which covered central bankers, regulators and Treasuries throughout the world. That line is not in the Conservative party Whips’ briefing, but it is absolutely true none the less.

Charlie Elphicke: Will the right hon. Gentleman give way?

Ed Balls: In a second.

And yes, it was a failure shared here in the UK, across the Treasury, the FSA, the Bank of England—and I have to say the then Opposition, too.

Let me remind the House that the legislation to give the Bank of England independence, and to shift from self-regulation to statutory regulation after 1997, for the first time established a Bank of England deputy governor with explicit responsibility for systemic financial stability and with an ex officio seat on the FSA board. As the seeds of the crisis were sown in the years before it, neither the FSA nor the Bank of England nor the Treasury rang the alarm bells, despite meeting every month in the tripartite standing committee.

The Chancellor, in a second breath a moment ago, said that we are now rightly taking the Treasury out of making such decisions, having criticised the Treasury for not triggering a crisis meeting that neither the Bank of England nor the FSA asked for—a point that seemed to be deeply confused. That demonstrates not that structures do not matter, but that there is no evidence from Britain or throughout the world that a different and arguably more complex structure, the new quartet structure before us, would have spotted a crisis that neither the Bank of England, the FSA, the Treasury, the Federal Reserve, the European Central Bank nor anybody in a regulatory position of responsibility spotted.

Gordon Birtwistle: Will the right hon. Gentleman explain the regulatory things that went on when the previous Prime Minister pushed Lloyds bank into buying HBOS, which was a catastrophe in itself? How much regulation went on then, and how much discussion went on between the Bank of England and the previous Government before it was pushed through by the previous Prime Minister?

Ed Balls: Those were decisions for the Chancellor and the Prime Minister of the day. I cannot give the hon. Gentleman a blow-by-blow account or any detail of what happened between the FSA, the Treasury and the Bank of England, because at the time I was the Secretary of State for Children, Schools and Families and was dealing with the failure of the test administrators to deliver the standard assessment tests for year sixes at the end of key stage 2.

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Alun Cairns (Vale of Glamorgan) (Con): Is the shadow Chancellor telling us that he accepts absolutely no part, bearing in mind his key role in the Treasury at the time, in the failure of the financial structures in the banking sector in recent years?

Ed Balls: I have apologised to the country and have asked the Chancellor of the Exchequer to do the same. Did this Chancellor ring the alarm bell in the crisis? No, he did not. Did he worry that regulation was insufficiently tough? No; he said in 2006 that financial regulation was

“burdensome, complex and makes cross-border market penetration more difficult”

and that it

“threatens the global competitiveness of the City of London.”

If the hon. Gentleman wants to have a debate about who should apologise and who should accept responsibility, he should look at the evidence and the judgments of the past 10 years. Let us not forget that it was the Conservative party that voted against Bank of England independence and the move from self-regulation of the City by the City to statutory regulation for the first time in this country. It was this Chancellor who personally opposed the rescue of Northern Rock, saying:

“I am not in favour of nationalisation, full stop.”—[Official Report, 19 February 2008; Vol. 472, c. 186.]

It was this Chancellor who opposed the rescue of RBS; who negotiated the flawed and foolish Merlin deal; who refuses to enact proposals on transparency for bonuses of more than £1 million; who resists the reform of remuneration committees; who is selling off Northern Rock at a loss, prompting a National Audit Office investigation; and whose decision to cut the deficit too far and too fast has choked off the recovery and led to us borrowing £158 billion more. We will take no lectures on judgment from this Chancellor of the Exchequer.

Charlie Elphicke: A few moments ago, the shadow Chancellor told the House that he had no involvement in the merger of Lloyds and HBOS. Will he confirm that he was not consulted, that his advice was not sought and that he provided no advice in relation to that matter?

Ed Balls: Yes.

I will set out what needs to be done to turn this bad Bill into a good Bill and to put the public interest, not party politics, in the driving seat in financial regulation. I will set out four objectives that should guide this legislation. The first is stability. We must ensure that we have a system of financial regulation that is robust in good times and in bad times. The second is to protect the taxpayer. We must guarantee that the public purse is protected from irresponsible decision making and wider systemic failures. The third is to be on the side of the consumer. There must be effective regulation, more competition and action on financial education and exclusion. The fourth is to support growth and employment. Let me take each objective in turn.

On stability, provisions to improve the structures for financial regulation and financial stability are at the heart of the Bill. As I have said, we support the FPC and we look forward to debating its powers. We are pleased that the Chancellor has today done a U-turn and decided that the Government will take up the

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recommendation of the Joint Committee that the macro-prudential tools to be used by the FPC should be properly scrutinised by Parliament. I hope that he will ensure that that happens not just when they are introduced, but when they are subsequently changed and updated. We believe that a new scrutiny committee should be established in this House to play that role. We will propose such an amendment.

On the splitting of the PRA and the FCA from the FSA—I know that these acronyms are hard to keep up with, but this is quite a complex system—it is fair to say that there are advantages and disadvantages. The jury is out. The Chancellor’s decision to put all this new and more complex architecture under the umbrella of the Bank of England, and arguably under the personal direction of its Governor, raises serious questions of accountability and clarity in decision making, as has been highlighted by the Treasury Committee and the Joint Committee.

We share the Treasury Committee’s concerns about accountability within the Bank and accountability to Parliament. As the Committee stated,

“the governance of the Bank needs strengthening and…it needs to be more open about its work. The Bank must be held more clearly to account”.

The Committee has proposed that

“the role of the Court of the Bank of England should be substantially enhanced. It should be transformed into a leaner and more expert Supervisory Board, with the power to conduct retrospective reviews of Bank policies and conduct.”

The Chancellor has said that he does not want to go down that road. He has made some moves, but we think that there is further to go to ensure that there is proper accountability. Again, we will propose reforms in Committee.

It is on the issue of crisis management and the processes for deliberation and decision making within the new, more complex structure, that we have misgivings. The Joint Committee was right to state:

“The powers and responsibilities of the Bank of England and the Treasury during a crisis are key.”

However, the Bill and the memorandum of understanding are deeply confused and opaque, as we have just heard from the Chancellor. We welcome the fact that the Chancellor has accepted the Treasury Committee’s recommendation that the Chancellor should be provided with a discretionary power to direct the Bank when there is a material risk to public funds. The British Bankers Association also welcomed that in its submission, but stated that it was

“unclear that the assignment of powers now proposed is consistent with the strategic division of responsibilities envisaged by the Government, including the proposed power of direction over the Bank.”

Article 20 of the memorandum of understanding exposes the hole. I will quote it in full:

“During a potentially fast-moving crisis, it will become especially important to ensure close and effective coordination so as to maintain coherence in the overall crisis management process. At the heart of institutional coordination during a live crisis will be frequent contact between the Chancellor and the Governor. However, the Chancellor and the Governor may agree to establish ad hoc or standing committees at other levels to support this process.”

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Under the Bill, there will be three deputy governors at the Bank, a new Financial Policy Committee, two new sub-agencies at the Bank—the PRA and the FCA—and a new quartet of relationships, in which there are separate statutory responsibilities for the Treasury, the FPC, the PRA and the FCA, as well as for the MPC. Will the Chancellor hear any of the views in a crisis, or pre-crisis, from the statutory office holders? Only, according to the MOU, if the Chancellor and the Governor decide that he should. It states that there will be frequent contact just between the Chancellor and the Governor. It is inevitable that there will be a variety of views and dissenting voices, not only at senior levels within the Bank, but between the different statutory agencies, because those agencies have overlapping and, in certain types of crisis, contradictory objectives. Those different statutory responsibilities are being put under one umbrella organisation—the Bank of England.

Matthew Hancock: Will the right hon. Gentleman give way?

Ed Balls: In a second. I will make the argument and the hon. Gentleman can then ask a question.

Senior and responsible figures who hold statutory offices will get to put their views to the Chancellor only if they are on one of the ad hoc or standing committees, which do not yet exist. It seems as though the Governor will decide whether they should exist at all and who should attend them. My advice to the Chancellor is that one cannot just rely on Treasury officials or gossip by the water pump. Unlike many of the Back Benchers who have intervened, I am not seeking to play a party political game; I want him to change the Bill. [ Laughter. ] Honestly. This is a deeply confused and highly dangerous ambiguity.

Matthew Hancock rose

Ed Balls: I will give way in a minute. Let me just make the argument, and then the hon. Gentleman, with all his experience of crisis resolution meetings at the Bank, can share his intervention with us.

In the run-up to a crisis or during a crisis itself, having such a high degree of ambiguity in the structure and placing such a concentration of power and access to the Chancellor in the person of the Governor would be highly unstable. If the deputy governor and head of the PRA—a statutory individual, but not the Governor—the head of the FCA or the majority on the FPC believed that there would be a systemic risk from one troubled company without support from public money, the Chancellor must know about it, and in time so must Parliament. They must know about it whether or not the Governor agreed. Whether or not the Governor believed that there was or might be a risk, and whether or not he believed that the moral hazard outweighed the risk, the Chancellor must know about it.

If the Chancellor wants a personalised, twin-peak system with all the responsibilities and accountabilities of the Bank of England located in just one person, the Governor, as is set out in the memorandum of understanding that he has negotiated with the Bank and as it seemed he did at times during his speech, the Bill is flawed. The new system will be unstable and the

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taxpayer will potentially be more exposed. All the statutory architecture of the FPC, the PRA and the FCA will be for the birds.

If, instead, the new committees and agencies are to have a separate statutory identity with clear and separate purposes that may sometimes conflict, and with leaders who must be properly heard, that must be clarified in the Bill. That was what the Chancellor seemed to suggest at other times in his speech, and the Bill seems to suggest it in places. It must be clarified not just in the memorandum of understanding but in statute.

The Bill sets out clearly the statutory identities of the FCA, the PRA and the FPC, which seems to suggest that the Chancellor intends to move from the tripartite system to a quartet system under the umbrella of the Bank of England—the Treasury, the FPC, the PRA and the FCA. If so, he should say so clearly in the memorandum of understanding and in legislation, for reasons of accountability, financial stability and effective decision making in a crisis. We will table amendments to that effect in Committee.

Matthew Hancock: I know that the right hon. Gentleman is desperate to defend the tripartite structure that he designed—

Ed Balls: Is that the best you’ve got?

Matthew Hancock: It is not, by far.

The accusation that the right hon. Gentleman makes undermines his point that the Bill sets out a quadripartite system. It sets out a bipartite system, involving the Governor of the Bank of England and the Chancellor. The fact that it will be delivered through the person of the Governor, who has to manage his own institution with appropriate accountability to court, means that it is a binary system rather than a tripartite one. It will therefore be better at resolving crises at the rushed times when they occur.

Ed Balls: I made it very clear that I was not defending any particular regulatory structure. I do not think the crisis was caused by institutional structures in particular, because other countries with different structures had a crisis as well. We will seek to support the Government in reforming and strengthening the system of financial regulation, including through the addition of the FPC and the new powers of the PRA and FCA. However, all those individual agencies are being given statutory authority in the Bill.

The Bill cannot be setting out a binary or twin-peak system, because there will be the Treasury and the Governor of the Bank of England, then underneath him there will be a deputy governor who is also the head of the PRA, another who is also on the Financial Stability Committee, the head of the FSA—also a statutory office holder—and another deputy governor on the Monetary Policy Committee. The Bill is designed to bring in not a twin-peak system but a quartet system, which will be more complex than a tripartite one.

There may be very good arguments for having a quartet system and for splitting the FSA into the PRA and the FCA, and I support the FPC, but the system will be more complex, not simpler. The Chancellor is trying to fudge the matter by giving the impression in the memorandum of understanding that it will be

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not a quartet system but a twin-peak system, because things will be sorted out between him and the Governor.

That is not an ad hominem point. Other Chancellors and Ministers from Governments through the ages have known very well that there is an inevitable conflict in financial regulation between the regulator, examining systemic risks from individual firms, and the guardians of the system, who worry about potential systemic risks on the one hand and moral hazard on the other. The Chancellor’s role is as the guardian of the public purse and wider financial stability, so there are different points of view.

My advice to the Chancellor is that to try to subsume all those points of view into a separate institution away from him, without transparency and with multiple and overlapping roles for different statutory office holders, but then say, “I’m only going to deal with the Governor,” is ahistorical, deeply foolish and flawed. If the Chancellor changes and clarifies the Bill, we will be pleased, but at the moment it is a terrible fudge.

Mr George Osborne: I hear the right hon. Gentleman’s criticism of our proposals, but what is his response to what my predecessor says? He has written:

“The whole system depended on the chairman of the FSA, the Governor of the Bank and the Chancellor seeing things in exactly the same way. The problem was that, in September 2007, we simply did not see things in the same way.”

My predecessor, who went through the banking crisis, says that he was dealing with a system in which differences of opinion were not accommodated. The system could not adapt to them, and there was no power of override. What is the shadow Chancellor’s response to my predecessor’s criticism?

Ed Balls: My response to the current Chancellor, who has not yet dealt with such a crisis, is “Welcome to the real world.” In reality, there will be times, as there have been, when the regulator, and potentially the deputy governor for systemic stability, will say, “We are really worried about the potential read-across from this particular large institution to the financial system more widely.” However, the Governor will say that for reasons of moral hazard and the desire not to set false precedent, he does not believe funds should be provided.

As the Chancellor has said, it is really hard when there is a disagreement between the regulator and the prudential systemic overseer or the Governor. The Chancellor has elected to take the power to make the decision in those circumstances. I agree with that strengthening of his powers, but—

Mr Osborne: You had the powers.

Ed Balls: The Chancellor does not listen. He wants to play this game so much that he does not hear. I agree with the increase in his powers. He is right to take them, but he cannot use them unless the Governor comes to him and says, “I fear a crisis may be building,” having made a judgment about moral hazard outwith the views of the heads of the PRA, the FCA and the FPC.

In the structure set out in the Bill, the statutory office holders will be formally kept out of the room under the Chancellor’s own memorandum of understanding, which is foolish. I understand why it has happened—it will be

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easier to negotiate. In all the years when previous Chancellors wanted clarity, it was hard to negotiate. However, negotiating the wrong clarity in a way that keeps information away from the Chancellor is not stabilising and in the public interest but destabilising, opaque and against the public interest. The Chancellor should take some advice from people who have seen that not working and ensure that he hears the views of the people to whom he is giving statutory responsibility in the Bill. That is my very strong advice, and I hope he will listen to it.

Mr Brian Binley (Northampton South) (Con): The shadow Chancellor is telling us something illuminating—that if a Chancellor does not want to listen, no system will have any impact at all. Under the last Government, siren voices started in 2002, and the then Chancellor refused to listen. We had a systemic deficit problem, and again he did not want to listen. The shadow Chancellor has been through all this, so would he advise the current Chancellor to listen more than the last Chancellor did during the crisis?

Ed Balls: My very clear advice to the Chancellor is that when he gives people a clear statutory responsibility for a particular function and legislates for three deputy governors who are the heads of individual agencies, he should also design his crisis resolution and decision-making procedures so that his experts are in the room and he can hear the array of their views. The idea that it is better for the Chancellor to require the Bank to resolve such issues internally and come to him with one voice—one Governor, one decision maker—is a flawed structure of regulation. The point, however, is that that is not what the Bill intends. It intends for the FCA and PRA to be important institutions, in which case the Chancellor should get them in the room.

Mr Robinson: Does my right hon. Friend agree that the further decision to install the Governor for eight years will make the inherent difficulty of dealing with only one person more difficult?

Ed Balls: I understand my hon. Friend’s point, but to be honest I do not have strong views on that. The reality is that there was not cross-party support or support more widely in civic society for Bank of England independence when we established it. The Conservatives voted against it. In those circumstances, it would have been difficult for the then Government to pass legislation for one eight-year term—there would have been a lot of opposition to the idea of giving one unelected individual such power for an eight-year term. This Bill moves us not only from a four-year to an eight-year term, but gives one individual massively more power than they ever had. That is what concerns me.

Charlie Elphicke rose

Matthew Hancock rose

Ed Balls: Oh God! It is a choice of two evils. Whom do I choose?

Matthew Hancock rose

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Ed Balls: Go on then. I will give way to the hon. Gentleman.

Matthew Hancock: I am very grateful to the right hon. Gentleman for giving way again. Does not his argument—that we cannot have an umbrella regulator under which inevitable tensions are resolved, and that we must instead have separate organisations—show exactly the thinking that led to the problems in the tripartite system, under which responsibilities were segregated and separated and problems fell between stools? The FSA and the Bank were told that one was to look at the regulation of individual banks and the other at the macro-economy, and never the twain shall meet. That is precisely the problem that needs to be addressed.

Ed Balls: The Chancellor referred to his years of thinking about this legislation. I am afraid that his former adviser demonstrates the kind of muddled thinking that has got the Chancellor into this difficulty.

I am not saying that the tripartite system is the best one. I am quite happy to go along with the shift to the quartet system—I can see the advantages of the FPC and the split of the FCA and the PRA. I am not worried because individual statutory agencies will be under the umbrella of the Bank of England; I am worried because the deputy governor and head of the PRA, who has a clear responsibility, is not part of the decision-making process. That is what I am worried about. I want the MOU to say that at the heart of the system—in pre-crisis and crisis—there will be a “clear view” group, in which the Governor and his key deputies, who will have separate and sometimes contradictory statutory responsibilities, come together with the Chancellor to make the decision.

Even if the Chancellor—this is not an ad hominem point—has the umbrella of the Bank of England and the quartet system, he should want to hear from the person whom he appoints on a very large salary and in law to be the head of the PRA. What I do not understand is why that would not be written into the MOU. Actually, I sort of do understand. There is a history in the Bank of England of the Bank equalling the Governor of the Bank—of wanting to personalise the appointment—as the Chancellor has described. However, we cannot personalise something as complex as the proposed system. It is not just that the system is complicated; there are also tensions and differences of view.

My right hon. Friend the Member for Edinburgh South West (Mr Darling) is quite right that it is hard to operate a tripartite system in which there are different views, but those differences will not be avoided by burying them under the table and pretending they do not exist. Had that happened at key moments in the previous crisis, the wrong decisions would have been taken.

Charlie Elphicke: I thank the shadow Chancellor for giving way once more. The Chancellor’s plan is for the financial and prudential regulation buck always to stop with the Bank of England. The shadow Chancellor has concerns about moral hazard on the part of the Governor, which suggests that he is not as strong a fan of the independence of the Bank as he has previously made out. Should we not trust a Governor of the Bank of England to work effectively with the Chancellor?

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Ed Balls: The hon. Gentleman does not understand that the buck does not stop with the Governor of the Bank of England, but with the Chancellor of the Exchequer, who, in the end, is the guarantor of the public purse and taxpayers’ money, and of the wider stability of the system.

If the Governor comes to the Chancellor and says, “In my view, and based on the views of my deputies, our collective view is to intervene,” the Chancellor has the power to do so. Rightly, the Chancellor has given himself the power in the Bill to override the Governor if the latter says we should not act. The concerning situation, which I am trying to explain—the hon. Gentleman does not quite get it—is that there will be different views within the overarching Bank of England, because it will be huge, with different, overlapping and sometimes contradictory statutory responsibilities for systemic stability, prudential regulation of individual firms and managing risks to consumers, let alone monetary policies.

In those circumstances, my strong advice to the Chancellor, with whom the buck stops, is that he should not allow the decision to be made in the Bank of England. He should not allow the Governor to say, “I know you want to act and that you want to us to act. Thanks very much, but I’m the Governor, and I don’t think we should.” We should not allow the Governor to tell the Chancellor, “The Bank does not propose action.” I would not put myself in that position.

The idea that such a situation is okay because the Chancellor will have heard before the meeting—from Treasury officials or on the grapevine—what those other office holders want is unbelievably naive. We are talking about the Bank of England’s legislative responsibilities and the statutory power of the office holder. In that key meeting of only the Chancellor and the Governor, the Chancellor cannot say, “I’m sorry, Governor, but other people take a different view from you.” That is not how it works.

Shall I move on, Madam Deputy Speaker? [Hon. Members: “Hear, hear!”] That is a very important argument to which we will return in Committee.

On Europe, that problem of complexity is mentioned in the Treasury Committee report, which states that there is

“a risk that the single UK regulatory voice in some cases is weakened by the fact that two or more organisations will share the representational role in the various international regulatory committees.”

The Chancellor has proposed a new committee, which is welcome, but I urge him to look harder at that arrangement. The Opposition will table amendments on that in Committee.

Let me move on quickly, because it is important to get other things on the record on Second Reading. As I have said, on consumers, the Opposition welcome the recognition of the need for a single regulator for all retail financial services, but we will highlight a number of concerns in Committee. In particular, we want to ensure that the FCA has the powers it needs to require providers of financial services to understand its fiduciary duties.

On disciplinary action, the Joint Committee has recommended a requirement to consult before disclosing the fact that a warning notice has been issued. We think the Government are wrong to reject that recommendation. That transparency should be in the Bill.

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The Joint Committee has also recommended that the FCA should be given concurrent powers alongside the Office of Fair Trading to make market investigation references to the Competition Commission. We do not understand why the Treasury has rejected that.

We are also disappointed that the Government have not used the Bill to bring forward the Vickers recommendation for a review of progress on competition. We propose having one in 2013, rather than in 2015, as Vickers proposed, not least because the Lloyds divestiture has so far not produced the strong, effective challenger that we sought.

The Chancellor says that he is in favour of financial education in schools and the Prime Minister says he is reviewing it, but they vetoed that proposal when a Bill was before the House. There is cross-party support on financial education. The all-party parliamentary group on financial education for young people is the largest such group and will propose an amendment for statutory financial education in schools for all young people.

The Opposition are worried that the Government are allowing the banks to go backwards on financial exclusion, with charges for basic bank accounts being increased in the case of Barclays, and with new charges on basic bank account holders using automated teller machines in RBS and Lloyds. We want to strengthen the obligation on the banks to produce a universal service for all retail banks. My hon. Friend the Member for Walthamstow (Stella Creasy) will no doubt push us to ensure that the Government agree to our amendments to give new powers to the FCA to restrain the ability of firms to charge ultra-high interest rates for prolonged periods.

On growth and employment, the CBI was right to say in its submission that

“the Bill should ensure that the new regulatory authorities have a specific objective to focus on—and support—economic growth.”

As it points out, the macro-economic tools used by the FPC could by their nature have a significant impact. The CBI says that the FPC should be required in statute to act

“in a way that is consistent with promoting the medium and long-term growth of the economy”.

The Joint Committee also proposed a strengthening of the growth obligation for the FPC, and we will propose amendments to that effect. I hope that the Government will look at this issue again, because it is important, not least for the supply of credit to small and growing businesses. Even the British Bankers Association says:

“We would suggest that the legislation underpinning the FPC should specify that its objective is to maintain a sustainable supply of credit to the economy”.

Bank of England figures show a £10 billion fall in lending to small businesses, and in November the Chancellor said that his new credit easing scheme would relieve constraints in the supply of bank lending in the short term. The short term is becoming the long term, because there is still no sign of that credit easing scheme. No wonder, with small business lending down and bonuses high, the Merlin deal is looking rather tawdry. At least the Chancellor has recognised that executive pay needs to be covered in the Bill, but as the Institute of Chartered Accountants said in its briefing,

“at the moment the Bill is drafted too broadly to be effective in encouraging proportional executive pay.”

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We will look at amendments in Committee and tomorrow the House will have the chance to debate the Opposition’s call for a repeat of the bank bonus tax to provide 100,000 jobs for young people.

This is a badly drafted Bill. On stability, there are gaping holes in decision making and accountability. On protecting taxpayers, there are flaws in the advice the Chancellor will receive. For consumers, there are flaws in the powers for referral to the Competition Commission and a worrying lack of action on financial education and exclusion. On growth and employment, there is a gaping gap that must be filled. We will not oppose Second Reading, but we want big changes in Committee. Otherwise, to protect stability, taxpayers, consumers, growth and jobs, we will have to vote against the Bill on Third Reading.

6.32 pm

Mr Peter Lilley (Hitchin and Harpenden) (Con): It is a pleasure to follow the shadow Chancellor, who began by promising us—somewhat uncharacteristically—a speech that would not be partisan or adversarial. I am sure that the House would have been as disappointed as much as surprised had he fulfilled that promise. I shall endeavour to do so for him because, as Chairman of the Joint Committee scrutinising the Bill, I had to adopt a more consensual approach than is sometimes my wont.

I am grateful to the Chancellor for responding so positively to the Joint Committee’s report and taking on board the substance and spirit of most of our recommendations. I hope that we have helped to make the Bill better. This was my first experience of the Joint Committee procedure, and I found it extremely productive, not least because the members, Chairman apart, were all of an immensely high calibre, brought great experience and approached their task in a thoroughly constructive way. However, it is salutary to remind ourselves that the first ever Joint Committee was set up to scrutinise the Financial Services and Markets Bill, which this Bill effectively replaces.

My Committee was conscious that, despite the eminence of our predecessor Committee, it did not diagnose the problems that subsequently ensued—above all the lack of focus on banking supervision and systemic stability. I hope history will not show us to have missed the elephant in the room.

The Bill is essentially about changing the structure of regulation from the tripartite system to a twin-peaks model in the light of the recent banking crisis. However, the Committee was struck by the weight of evidence for two things. First, no system of regulation can guarantee that there will never be another banking crisis. Consequently, it is essential to have a process in place to resolve the situation if banks get into problems. I urge the new FCA to make it a priority to see that major banks draw up their living wills as soon as possible. It is also essential to know who is in charge if a serious crisis erupts. We heard from the previous Chancellor that during the last crisis there were serious differences between the Treasury and the Bank of England and no easy way to resolve them. We recommended that, once the Bank has identified that a problem could lead to a call on public funds, the power to exercise responsibility should

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lie with the Chancellor, even though he may continue to leave that power in the hands of the Governor. I am pleased that the essence of that recommendation has been adopted.

The second point made by many witnesses was that regulatory structure is less important than the culture, focus and philosophy of the regulator, as the shadow Chancellor reminded us. That culture will depend crucially on the leadership, staffing and training of the new regulatory bodies, which are beyond the scope of this Bill. The only way in which legislation can influence the culture and focus is by setting clear objectives, powers and responsibilities, and systems of accountability for each of the new bodies. We made a number of detailed recommendations to clarify those and I am glad that most have been taken on board.

The House will be relieved to hear that I do not propose to go through all 70 recommendations item by item, but the biggest change of culture is from what has been described as box-ticking regulation to discretionary or forward-looking supervision. The Government advocated that change before the Joint Committee was established, but we found it hard to see where in the Bill the approach was given legal backing, especially for the Prudential Regulation Authority. I hope that the Chancellor is confident that regulators will be fully empowered under the legislation to behave in that way.

As our work progressed, the Committee became increasingly aware that, however well drafted, the Bill will have a decreasing impact on how the British financial system operates, as regulations are increasingly being set at a European level. A veritable tsunami of EU regulation is about to wash over the City, so it is vital that the UK exercises the maximum influence on decision making in Brussels. However, the architecture of the regulatory structure being created in Brussels is different from that in the UK. It’s is based on sectors and ours will be based on prudential and financial conduct. There is a danger that our lobbying input to the EU regulators will be fragmented, divided and weakened as a result. We therefore proposed the establishment of a high level committee, chaired by the Treasury and reporting to the Chancellor, to co-ordinate the UK lobbying effort in Europe of all the bodies created by the Bill, and in international forums such as Basel. I am glad that that recommendation has been adopted in the memorandum of understanding between the various bodies, but it is obviously also important closely to consult financial firms—both British and foreign—that do business in London, Edinburgh and elsewhere in the UK, whose lobbying power also needs to be deployed in Brussels.

I should mention that while I was in Brussels last week on other business I had the opportunity to meet Monsieur Barnier, the commissioner responsible for most of the proposed financial services legislation. I am grateful to him for seeing me. When I told him that many of us on the Committee had been surprised to learn about this tsunami of financial services legislation descending upon us, he rightly said that we should not have been. The measures were in the public domain and followed from the decisions of the College of Commissioners and the Council of Ministers. He is correct. Mea culpa—or nostra culpa: the fault is ours in this House if we pay too little attention to what is brewing across the channel until it is too late. The

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European Scrutiny Committee does sterling work, but I wonder whether our procedures need to integrate its work more closely into our process of scrutiny on the Floor of the House, bringing Ministers here to explain our negotiating position at an early stage.

Kelvin Hopkins: As a member of the European Scrutiny Committee, I appreciate what the right hon. Gentleman is saying, but does he not agree that it would be strengthened if the European Standing Committees had permanent instead of ad hoc membership which means that the work is not taken so seriously?

Mr Lilley: That is probably a good point, and I hope that the relevant powers will listen to it.

When Monsieur Barnier came to London a few weeks ago, he defended his legislative programme as necessary to creating a single market. If it would create a single market, most Members on both sides of the House would wholeheartedly support it—I certainly would—but I cannot see how any of the measures will open up a single new opportunity for financial companies to trade outside their own national markets across the single market beyond what is already open to them. Most if not all of the directives are about centralising regulatory powers over the financial sector in Brussels rather than in nation states.

Monsieur Barnier did not dispute that, but he argued that the financial crisis had been caused by lack of regulation of “British and American banks”, so it was essential to impose regulation at an EU level. I gently reminded him that the credit crunch had been sparked when a French bank, BNP Paribas, announced it could no longer put a value on its property funds, that it subsequently emerged that continental banks had far higher levels of gearing than Anglo-Saxon banks, and that the current euro crisis is, at its heart, a banking crisis, as continental banks are so under-capitalised that they cannot absorb the losses on their holdings of sovereign debt and their Governments cannot afford to recapitalise them openly and immediately, as British and American Governments did.

Monsieur Barnier also argued that a single market requires a single rule book. However, that was promptly negated by his promise that that does not mean a one-size-fits-all regime and that

“we also need to allow considerable flexibility for national supervisors”.

Either there are separate national rule books, or there is a single EU-wide rule book. We cannot have or pretend to have both—or rather we can, and in a sense we do. Under the second banking directive, any bank or similar financial firm can operate anywhere in the EU under the supervision of its home authority, so any individual bank can operate under a single rule book throughout Europe. Of course, that rule book must obviously meet minimum requirements agreed at EU level. I believe that that is the model that we should retain and encourage across Europe within the single market.

That brings me to the issue of the draft fourth capital requirements directive, which will implement the Basel III agreement. The Committee discussed it at length with Mr Enria, chairman of the European Banking Authority, who strongly defended the EU’s decision to set not only a minimum level of reserve that each country must require its banks to hold, but a maximum level that banks can be required to hold. We subsequently wrote

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asking for clarification of his reasons for setting a maximum, but found his arguments unconvincing. His claim that our setting a higher rate would somehow siphon off funds from other countries, or that it would be unfair if we made our banks safer than those of other countries, were not entirely convincing.

In the light of the Committee’s experience, my interview with Monsieur Barnier and the evidence from Mr Enria, I believe strongly that the Prime Minister was right to seek to reintroduce what Monsieur Barnier called a dose of unanimity in decision making on financial markets. I hope that the Prime Minister will continue to press that with the support of both sides of the House.

6.43 pm

Mr Nicholas Brown (Newcastle upon Tyne East) (Lab): Along with my hon. Friend the Member for Leeds East (Mr Mudie), I represented the parliamentary Labour party in the Commons on the Joint Committee of both Houses that gave the Bill pre-legislative scrutiny. It was a pleasure to serve under the chairmanship of the right hon. Member for Hitchin and Harpenden (Mr Lilley), whom I thank for his fair-minded chairmanship. I also thank the impressive array of witnesses who gave up their time—in some cases very valuable time—to help the Committee in its deliberations.

I echo the right hon. Member for Hitchin and Harpenden in commending the Joint Committee’s report to the House. The Bill essentially addresses itself to the structure and powers of the financial services regulator. It does so at a time when the whole world is facing up to a debt and liquidity crisis and when the financial services sector is viewed by the public with even more distrust than is normally reserved for politicians and journalists.

I do not want to spend much of my remaining eight minutes dealing with the point on which the Chancellor focused. He certainly decided not to waste a good crisis. He focused on the structural questions involved. I do not think that it is primarily a structural question, and that view was shared by the Committee. Structures and architecture are not the root cause of the problem. As my right hon. Friend the shadow Chancellor said, other countries with different regulatory structures faced similar problems. It is not a structural question alone; it is also about the power, scope and information available to the regulator.

It is also—dare I say it—about the behaviour of the regulated. Effective regulation flows from getting the culture, focus and philosophy of the regulator right, as we concluded in the pre-legislative scrutiny report. We as a House should be far less tolerant of the evasive and litigious behaviour of some of the regulated. We should expect the regulator to take an interest in gathering market intelligence and anticipating emerging problems. The focus on that is one of the strengths of the proposed new architecture. It will involve co-operating closely with the regulatory authorities in other jurisdictions, particularly the United States.

If we believe that it is necessary in the broader public interest to regulate the financial services sector trans-nationally, why are we so acquiescent in the existence of a flourishing shadow banking marketplace? What defensible public purpose does that marketplace serve? What is the justification for the almost impenetrable complexity of its transaction structures? Surely the only two possible

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reasons for it are to avoid transparency and therefore evade the regulator or, somewhere in the details of the complex structures, to turn a small additional margin of profit on very large sums of money at the expense of the unwary. I ask again: why is that in the broader interests of society?

The Committee went to some trouble to establish the balance of power between the proposed new European regulatory architecture emerging from the Basel III process and the new United Kingdom structures. The question is important, and I am pleased that the Chairman of our Committee referred to it. The Commission’s intention is that the European Union’s regulatory regime will be mandatory for all European member states, including us, and will be asserted centrally, not legislated for by national legislation.

The Prime Minister has assured the House that it is the Government’s intention that the European Union regulatory regime should apply to the United Kingdom. The European Union regime will act as a constraining factor on UK regulators, a point that the right hon. Member for Hitchin and Harpenden made in his speech and that I hope the Minister will address when he winds up the debate.

As I argued earlier, the forward-looking, judgment-based regulatory regime must be well informed if it is to function adequately. I thought that the Governor of the Bank of England was clear on that point when he argued that the Financial Policy Committee should have the power to request information from regulated firms and determine the time frame in which that information should be sent. The Chancellor, in his address to us, seemed to support the regulator having that power. If that is his view, it is mine as well, but to the Committee, the Government seemed to be arguing for a more tortuous process that would require Treasury consent and even parliamentary approval. That does not capture the sense of urgency and the need for firmness. We should back the regulator.

While I am on the subject of timely intervention, the Bill is said to be admirably clear on who is in charge during a crisis. The Chancellor made much play of that in his address to the House. The trigger will be the potential need to call on public funds. It is essential, though, that the Chancellor be alerted, at the earliest possible moment, to an emerging situation of that kind. If there is any doubt about that, the Chancellor should get the benefit of the doubt. If he is told only at the last minute, the Chancellor will not be left with a wide range of choices, and none of them will be particularly palatable.

The effectiveness of judgment-led regulation will rest on the quality of the individuals working for the regulator. The Governor argued for a dedicated team of public servants working in a public-service culture who are able to look to a dedicated career in regulation. I believe in public service and share the Governor’s point of view. Such a career should be well-paid and the public servants should be beyond corruption and intimidation. They should be protected by transparency, powerful criminal sanctions and a new parliamentary committee acting as Parliament’s interface with the Governor and his deputies as regulators.

The regulatory system should focus on the protection of consumers and the taxpayer.

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Kelvin Hopkins: Everything that my right hon. Friend is saying suggests that we are re-empowering Parliament when it comes to how our economy is run, which is the opposite direction from the one in which we have been moving in recent years. Is that not welcome, and does it not strengthen our democracy?

Mr Brown: We need to go further. How Parliament interacts with the Governor in his new role as regulator has not been properly addressed in the Bill, but we need to think about that carefully. Although finding fault with every other structural problem with financial services, the Government propose no change to the arrangements for the accountability of the regulator to Parliament. Accountability, therefore, is through Ministers, primarily Treasury Ministers, or through the work of Select Committees, primarily the Treasury Committee, which is one of the hardest-working Select Committees in the House of Commons. We should consider whether that is adequate. As the new arrangements come into effect and settle down, alongside the recommendations from the Independent Commission on Banking, surely there is a need for an authoritative forum in which emerging issues can be examined, ideas explored and recommendations made. Public discussion and transparency are important safeguards.

The other place, too, has a legitimate role in these arrangements. Acting as a check and balance on elected representatives, and public life more generally, is what the other place, as currently constituted, does well. In any event, we should consider very carefully whether we are satisfied with the present arrangements alone. Perhaps this is a suitable subject for a separate debate.

Private sector financial services in the United Kingdom are underpinned by the public sector in a number of important ways. The most significant are the £85,000 deposit compensation limit guarantee; even more importantly, the Bank of England’s role as lender of last resort; and the need to intervene when private sector misjudgments threaten a collapse of the banking system. We, as the people’s representatives, should take an interest in this democratic deficit.

There is a third point to consider. Each of us is elected to represent our fellow citizens. There is nothing more frustrating and upsetting for a constituency MP than to know that individual constituents are faced with an injustice and that there is no effective remedy. Such situations occur far too frequently in the financial services sector. One thinks of the present Arch Cru scandal as the latest of a depressingly large number of similar scams.

I welcome the fact that the Bill gives the FCA powers to intervene in the case of individual products and their promotion. The Bill allows consumer bodies to make super-complaints to the FCA and facilitates a reform of consumer credit with a view to better protecting consumers. That is welcome too. It is important to ensure, however, that the FCA’s strategic objective is clearly stated. I was taken by the suggestion from Which? of

“ensuring a fair and transparent market in financial services”,

which is reflected in the Joint Committee’s recommendation that the FCA’s strategic objective

“should be amended to focus on promoting fair, transparent and efficient financial services markets that work well for users.”

That is more specific than the Bill, as drafted, which refers to

“ensuring that the relevant markets function well.”

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The phrase is too general—how else would one want markets to function? There are still concerns that section 348 of the Financial Services and Markets Act 2000 is too restrictive and discourages the publication of information. I hope that the Minister will have something to say about that, because I know that the Government propose to address the matter in Committee.

We are expecting a lot of the new structure and are placing yet more responsibility on the shoulders of the Governor of the Bank of England. The new role has been described as similar to that of a sun-king presiding over an empire. There is clearly a democratic deficit in the new structure that ought to be addressed—

Madam Deputy Speaker (Dawn Primarolo): Order.

Mr Brown: I say: “Every man a king, but no man wears a crown.”

Madam Deputy Speaker: Order. The right hon. Member is not supposed to take up other people’s time.

6.55 pm

Mr David Ruffley (Bury St Edmunds) (Con): It is a pleasure to follow the right hon. Member for Newcastle upon Tyne East (Mr Brown), most of whose comments I endorse. The regulators failed to see the crisis coming and were asleep at the wheel, so it is entirely right that the Bill abolishes the Financial Services Authority. In so doing, however, it gives new extensive powers to the Bank of England, and that poses a problem: will the newly created bodies—the Financial Policy Committee and the Prudential Regulation Authority—be as accountable as possible? In that respect, the right hon. Gentleman was right to touch on the democratic deficit.

I had the privilege of sitting under the chairmanship of my right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley) on the Joint Committee, and I also sit on the Treasury Committee. Those two bodies have one thing in common: in respect of the Bill, both are concerned more than anything with the accountability of the Bank in its new form and with its new powers.

I want to raise three points that the Government have not yet taken on board—they have taken on board some good points raised by the two Committees, but some are outstanding. First, to whom exactly will the PRA and the FPC be accountable? Let us remember how important and powerful these two bodies will be. The FPC will have an overarching responsibility to maintain financial stability, and it will be chaired by the Governor of the Bank of England. The PRA, also chaired by the Governor, will have macro-prudential responsibility for supervising significant financial institutions, particularly the banks. They will also have all sorts of macro-prudential tools, the details of which are yet to be designed—but they will include things such as loan-to-value ratios for mortgage lending, leverage ratios and so on. Those are hugely important tools that will affect the livelihoods and household finances of all our constituents.