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CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-iv
HOUSE OF COMMONS
HOUSE OF LORDS
TAKEN BEFORE THE
PARLIAMENTARY COMMISSION ON BANKING STANDARDS
WEDNESDAY 24 OCTOBER 2012
SIR DONALD CRUICKSHANK
Evidence heard in Public
Questions 146 - 205
USE OF THE TRANSCRIPT
This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Commission, and copies have been made available by the Vote Office for the use of Members and others.
The transcript is an approved formal record of these proceedings. It will be printed in due course.
Taken before the Parliamentary Commission on Banking Standards
on Wednesday 24 October 2012
Mr Andrew Tyrie (Chair)
Lord Lawson of Blaby
Mr Andrew Love
Mr Pat McFadden
Examination of Witness
Witness: Sir Donald Cruickshank gave evidence.
Q146 Chair: Thank you for coming to see us this morning. This is well-rehearsed territory for a number of us. The Treasury Committee has been grateful for your trenchant evidence in the past, and we are hoping for more of the same this morning.
The focus of the Commission is very much on standards. With that in mind, perhaps I could open by asking you what contribution, if any, you think that competition can make to improving standards in the banking industry.
Sir Donald Cruickshank: Quite a lot, I think. I will deconstruct the banking industry. In the markets for retail customers and small businesses, for deposit taking, for secured and unsecured lending, for credit cards, and for current accounts obviously, it is my view that the promotion of competition-that is policies that would get us to a higher level of competition than we presently have in the UK-would have a very helpful effect on the standards of behaviour of the firms responsible for running businesses in those markets. You will notice that I have been careful to identify the markets in which I think it would work.
All these markets rely, however, on the underlying networks-what we call the money transmission systems, whether it is the ATM system or the way in which we transfer money between bank accounts or the credit card systems. There, because of a network effect, competition is less easy to deliver from a policy perspective, and there I think you need invasive and harsh regulation to allow competition to flourish in the markets that I have defined. It is not enough, however, because I would just observe en passant that competition in investment banking is quite robust. There are other issues to be considered, but the answer to your question is yes, in the markets I have defined, assuming that the underlying networks are properly regulated.
Q147 Chair: What do you think will happen to standards? Why do you think there will be this improvement in standards? Will it be because people will be able to switch-they will get sick of bad treatment and go somewhere else? What will be the trigger for it?
Sir Donald Cruickshank: I am making an assumption that the Banking Reform Bill will become an Act with the substance with which it is being presented, with some security that it will not be eroded by the actions of Treasury Ministers in the future. The Bill, with Vickers, is carving out exactly the markets that I have been discussing here. If that happens, you have an executive team in a bank responsible for these markets that is secure in its capacity to go about building business in these markets without the threat of its capital being deployed in other activities, or other activities impeding its ability to compete in these markets. There will then be, I believe, different expectations about incentives, compensation and a whole range of other issues in that bit of the bank and in these marketplaces.
Having said all that, however, a bank manager, or whatever we call them now-a regional lending manager-thinking that he might lose 10%, 15% or 17% of his business on Monday morning because of the competition in these markets, will have a very salutary effect, which presently is not there. It will oblige that person to think about the relationship with customers, to listen to customers, and to be alert to and act on complaints in a way that they do not do now.
Q148 Chair: That is very helpful.
You wrote a pretty robust report over a decade ago on a wide range of these issues and virtually none of it has been implemented.
Sir Donald Cruickshank: Correct.
Q149 Chair: Why is that?
Sir Donald Cruickshank: It tends to get forgotten that there were two reports. The first report was an attempt to persuade the then Government, and particularly the Treasury, to give the FSA a primary objective to build competition. That was rejected by the Government, I believe on the grounds of-one of your members may be able to inform you rather better than me-sheer parliamentary time and the complexity of the Financial Services and Markets Bill, which was going through the House at the time I was doing the study.
I suspect that it was also felt that it just was not appropriate to give a financial regulator a primary duty to promote competition, and to give that regulator powers under competition Acts to act in its own right-i.e. not just refer issues to the OFT and the Competition Commission. That debate has gone on for a decade. It is has now been responded to in part-but, I think, unhelpfully-in the present legislation. There is a sense in which the FCA is being given a competition objective, but it isn’t really, and crucially regarding the PRA-although I must say that I find the Financial Services Bill extraordinarily difficult to follow, and it is difficult to work out what its consequences might be, and particularly to begin to form a judgment about what its unintended consequences might be-the discussion there seems to be silent.
That is one reason why we have seen little change. The second reason is that there was an unwillingness to regulate properly the networks over which the banks provide retail services. That went from a commitment on the Floor of the House from Gordon Brown to legislate to provide for that to the creation of an industry-dominated Payments Council. That debate is now back on the table with the Government consulting on whether we stay the same. I think there are three versions, the last of which would1 be close to my original recommendation, which is that someone with competition powers should be given the job of licensing and regulating the underlying networks. So that is back on the table, but we have lost a decade.
I will just pause there. Those are the two main things, but there was a whole lot of other stuff in the report, particularly about providing services to small businesses, where the competition authorities lamentably failed not just to act, but to provide what would be, for competition authorities around the rest of the world, a common analysis of what was happening in that sector. These are the three. Nothing has happened to the provision of services for small businesses.
Q150 Chair: There is a lot to chew on there. Let us just take the first of those and break that down into three parts. On the FCA, you said that it appears to have been given a competition objective, but not really-or words to that effect. Is that because of the concern expressed by the Treasury Committee, among others, that there is an overarching objective that can trump the objectives beneath it, one of which is now competition, or is it some other cause?
Sir Donald Cruickshank: Just for your colleagues, recall that I have been a regulator, albeit of telecommunications. Presumably we may come on to account portability at some point?
Chair: We will.
Sir Donald Cruickshank: I am not expert but, by heavens, you sit in the office of the regulator with the lawyers as you move towards significant decisions, and-you parliamentarians will like this-you do really have to understand not just what was said by Parliament in debate, but what the words in the Act actually mean. I can tell you that if the Financial Services Bill becomes an Act in its present form, with that wording for the FCA relative to competition, it will have a minimal impact on the decisions of the FCA, because it is not a primary objective-it is qualified. Through that sentence, Sir Humphrey lives, because there are three qualifying phrases before the word "competition" is mentioned. In other words, if anything is clear, it is that you will make this objective subservient to any other objective you may possibly have, or consider that you have. That is how I would read it. It is not far short of saying just "have regard to".
Q151 Chair: Which was a flop, as we know. "Have regard" was ignored.
Sir Donald Cruickshank: If, as a regulator, you sit down with the lawyers and say, "What does ‘have regard to’ mean?", they will say, "Have regard to?" You have to record that you have had regard to the issue, produce some documentation that demonstrates that, and then get on with your decision making.
Q152 Chair: I don’t want to put words in your mouth, but do I take it that a recommendation to the Commission might be for us to look at ways in which that wording can be beefed up?
Sir Donald Cruickshank: Yes. Plus.
Q153 Chair: Plus?
Sir Donald Cruickshank: The institution needs to be given powers to act, in my view, within the competition law. If an issue arises for the FCA or the PRA, where other objectives are being constrained because of weak competition, I do not believe that a referral to the competition authorities is sufficient for this particular sector of the economy. My premise in all of this is that banking is a part of the state, and that there is a deep and important regulatory contract between the state, as represented by Parliament and the Executive, and the banking industry. It is the terms of that contract that really matter and the fact is that that contract failed, which took us to 2008. This sector demands-for security, efficiency and prosperity-invasive and harsh regulation. If those who enter the industry think that is unfair, they can go off and do something else.
Q154 Chair: Rather than prolong discussion of that point now, we would be very grateful if after this meeting you would be prepared, on half a side of paper, to set the main subject headings down of what would be required on how we need to sort out that bit of FCA legislation to make it work.
I said that I wanted to break down the first of your three points into three. You also mentioned the PRA, but the PRA does not have a competition objective.
Sir Donald Cruickshank: If a regulatory body that is overseeing the activities of a sector of the economy that is central to the operation of the state does not have a competition objective-I am not talking about regulating doctors or nurses or indeed bankers themselves-it is very likely that competition will be muted. Because it is then in the interests of both the regulated and the regulator to keep competition muted. It is easier for both parties-the regulator and the regulated-if competition is muted. It would be extraordinarily difficult for the PRA in this case, if it thought that its objectives might be better delivered via better competition in a particular sector of the economy, to act to achieve that. Equally, I do not quite understand how the relationship between the Bank, the FPC, the PRA and the FCA is going to work. I find it quite difficult to go further than that.
Q155 Chair: The third tranche of your first point was that the Bill is hopelessly complex because it uses amendments to the already very complex Financial Services and Markets Act. First, is that now an irreparable problem or do you have any specific proposals on how we might remedy it? Secondly, do you think that it is so bad that, even if it took more time, we should consider advising the Government to go away and write this Bill properly, as a new Bill? That is what the Governor of the Bank proposed.
Sir Donald Cruickshank: I am very tempted to say yes, but to be honest that would be on the basis of rather thin investigation or thought by me.
Q156 Chair: In which case, we are back at the first of those two. Is it irredeemable? Can it be remedied or are there palliatives, and if so, what are they?
Sir Donald Cruickshank: Let me offer one thought. We have time, oddly enough, because the worst excesses and the worst risks are behind us.
Q157 Chair: But the Government are determined to get this on to the statute book by December.
Sir Donald Cruickshank: I understand that. All I am saying is that the difference to the economy and our prosperity between this December and next December is highly likely to be close to zero. If you were to conclude, gentlemen and lady, that it is irredeemable, I would be minded to agree with you and suggest that the Government takes time. I had not realised that the Governor thought the same, in which case I feel I am in good company.
Q158 John Thurso: Sir Donald, thank you for your brief, which was an absolutely gem-laded submission.
Sir Donald Cruickshank: I tried to get it on one page, but it was difficult.
Q159 John Thurso: It was refreshingly easy to read. Can I come to the point you were discussing a moment ago, which is the overriding principle that the banking system is de facto part of the state? "The banking system" is quite a wide and all-encompassing phrase. Do you have any thoughts about which parts are directly part of that contract with the state? One of the things we are looking at, clearly, is the ring-fence concept-Vickers versus Volcker versus Liikanen. Do you have any more thoughts on that?
Sir Donald Cruickshank: Vickers, and its consequences, is quite a helpful descriptor of what I mean by "The banking system" in that sentence. The consequence of that is that I am saying that most, if not all, of the activities identified as investment banking may be important to the economy-and, indeed, for the UK they are very important, in the international sphere-but they are not central to the operation of the state, which is about credit cards, deposit taking, security and the trust that individuals and particularly small businesses-anybody who is not a grown up-can have. Investment bankers are, by and large, dealing with grown ups. They can operate from all parts of the world. The problem there has been that there was too easy access to capital and too many fingers in the pie, but something has been done about that.
Q160 John Thurso: Your 2000 report made it very clear-it had quite a lot of words pointing this out-that you were not discussing investment banking.
Sir Donald Cruickshank: I was asked not to, actually.
Q161 John Thurso: So when you talk of the banking system, we are talking about the utility end of it.
Sir Donald Cruickshank: About the markets I described in the answer to my first question, plus the underlying money transmission systems.
Q162 John Thurso: The other point was the very last thing that you said in your submission, which was, "Do not call for, or worse, attempt to legislate for shareholders to bear the government’s supervisory role of the governance of financial institutions." Obviously, corporate governance and looking at standards are a key strand of the work we are doing and at first glance that statement might be construed as being the opposite of Kay. Is that a correct construction or not?
Sir Donald Cruickshank: The opposite of?
John Thurso: The Kay report on stewardship, which came out-
Sir Donald Cruickshank: It is. I think that is fair. It would be very easy for the Government or for Parliament to be precise to impose obligations on the shareholders of licensed bank activities that would be different from the rest of the economy. I do not think that the institutions are capable of delivering that and I do not think they would want to. In my view, anyway, it would be Parliament and the state trying to delegate responsibility that is properly theirs. I am recommending legislation that is specifically aimed at the boards and, in particular, committees of the boards of institutions that are licensed activities. In other words, we should legislate to make the onus on them harder and harsher by exposing them to civil and criminal penalties and not ask shareholders as our agents to do that job for us, because I do not think they are able to and I do not think that they want to.
Q163 John Thurso: In as much as there may or may not be an argument-a reasonable intellectual proposition-that financial institutions are of a complexity that they require more governance than another FTSE 100 company that is non-financial, that extra comes by regulation, not by an extra imposition on the shareholder.
Sir Donald Cruickshank: Correct.
Q164 John Thurso: May I turn to the state of the retail banking market, as it were? One of the things that has happened as a result of the crisis is that the market has become even more concentrated than it was when you were reporting a decade-plus ago. Is there anywhere in retail banking where effective competition actually exists?
Sir Donald Cruickshank: It does in one of the markets that I have described. Deposit taking, interestingly, which is, in other words, the ease with which a small business or a retail customer can, if they have surplus funds, move money around and choose to have it on call or to deposit it and lock it away for three years at a different rate. That is not bad, in my view. It is when we come to lending and the current accounts markets and almost everything for small business that there are real problems. I would not be too gloomy. Although I have not done the study again, one of the conclusions that we came to in 2000 was that the UK’s consumers and small businesses are relatively well served compared with the rest of the world. I doubt whether that that has changed much, but it could be much better.
Q165 John Thurso: Recently I had a discussion with a very senior banker who puts himself across as being an old-fashioned banker who wants to have a relationship. I put to him this question of competition and that you need a diversity of institutions to have effective competition. His view was that three institutions that competed effectively were better than 20 that did not. That is the supermarket model, where we have four or five supermarkets and everyone does very well out of it. To what extent do you subscribe to that and to what extent should we be very wary of that analysis?
Sir Donald Cruickshank: I subscribe a bit to that. Do you know which Government actually acted on my report? Australia. At the time, Australia was contemplating moving away from its "We shall have four banks" rule. I remember talking to the chair of the Australian Competition and Consumer Commission and also the head of its Treasury, and from reading my report, they had, for whatever reason, sort of shifted towards thinking, "This is a special sector of the economy. It is effectively part of the state. Our four banks, with appropriate regulation, is the best policy position for us to take." I am not suggesting that we go to four in the UK, although, de facto, we have five, and entry is extraordinarily difficult. The fact is that we would continue to have a reasonably concentrated banking market in the markets that I am talking about and a wholly concentrated market-a monopoly-in the money transmission systems. We could thrive on that.
However, it is not for us or for Parliament to decide that in advance. We need to provide for easier entry. We need to have the mechanisms to manage exit, which I think we are getting. We need to have some regulatory interventions, particularly in the area of current accounts and in providing services for small businesses. If we had that, it would not surprise me if we continued to have quite a concentrated market, but that would be more because that is what consumers wanted and not because of what Parliament, or indeed the five major banks, imposed on them.
Q166 John Thurso: You said that competition is working quite well in deposit taking. People can shop around, and I rather agree with you on that. The problem is with lending. The key piece of lending to most individuals is getting their mortgage. Already in 2000, there had been a pretty intense concentration of provision. When I was looking for a mortgage, banks were not allowed to give them, and there were 20-odd mutuals that you could try and go to. In the ’90s, there were still quite a few mutuals and some of them had turned into small banks. We are now in a position where there are a very, very small number of providers. Is that a particular area of concern?
Sir Donald Cruickshank: It is actually quite hard for me and your good selves to be undertaking this survey just after the worst crash we have had, because underlying all of this is a set of decisions made throughout the late ’90s and into the 2000s by central banks about money supply, printing money, aversion to dealing with asset bubbles, etc. In Basel II, we effectively let the banks decide what risk meant, and their balance sheets broadly doubled. Different ratios produce slightly different numbers, but their balance sheets doubled relative to their capital in about six years. Let us not confuse the unravelling of that with whether we have effective competition in a particular market in the UK, because I suspect that it has an awful lot to do with the unravelling of the poor policy and the excesses that followed in the early part of this century.
Q167 Mark Garnier: Sir Donald, may I turn to regulatory barriers to entry? Have you spent any time really looking at the current process by which new entrants can come into the market in terms of applying for banking licences?
Sir Donald Cruickshank: No, I do not need to. There will not be any. Well, sorry, that is a gross exaggeration; I was too flippant. It will be extraordinarily difficult for a genuine new entrant to come into this marketplace.
Q168 Mark Garnier: So the fact that we have had only one ab initio banking licence granted in the past 100 years or so-to Metro Bank-does not surprise you in the slightest.
Sir Donald Cruickshank: No, and given the Financial Services Bill as it stands and the new regulatory arrangements, there will be a natural conservatism in the minds of those charged with executing policy. I would be gloomy about new entry.
Q169 Mark Garnier: Your views very much mirror mine, having spoken to a number of aspirant banks that have tried to come into the marketplace and, indeed, some banks that have actually been granted transfer banking licences when they have had a change of controlling interest on the banking licence. The experience has been truly breathtaking. One of the people I have met, out of 12 of these individuals, agreed that the process is probably quite a good thing. Eleven of them talked of endless horror stories with the FSA, to the point when even just opening a dialogue to have a banking licence can cost anything up to £1.5 million-just to prepare the paperwork to then have a proper discussion. Presumably, that does not shock you at all.
Sir Donald Cruickshank: That was not the question you asked. You asked whether there would be any more banks. No. Does it shock me? No, it doesn’t shock me. In a sense, it doesn’t surprise me, for it is exactly the behaviour that I would expect from an organisation-going back to my previous answer-that does not have an objective to promote competition. It is in the interests of the regulator and the regulated-in this case, the five major banks-for different reasons, not to have effective new entry. If we do not write the framework right, we will not get the outcomes we wish.
Q170 Mark Garnier: I turn to the 47 or so smaller banks in the marketplace, some of which are as small as Kingdom Bank, with a balance sheet of just £50 million, with others slightly bigger. In a typical conversation with them, they are very frustrated with the fact that the rules being applied to them have the effect of being much more onerous, given that they have far more limited resources to deal with the compliance policy. Have you done any work in that area?
Sir Donald Cruickshank: Not since 2000, but I have no reason not to believe that, perhaps notwithstanding some of the more welcoming words, the reality is as it has been for a long time in the UK.
The hope was that as banking markets became more international-sorry, as banking firms became more international for the markets are still local or national-there would be the entry of those that even the FSA could not reject because of their scale, competence and so on. That has not happened. Again, it is probably a result of the crash of four years ago that there has been a contraction back into national markets by these very firms. The last thing on their mind is to enter new markets and start up new operations, so we do not have that. We have great difficulties with a small bank or even a big bank-even someone with significant resources-becoming a bank in the UK. This is the realpolitik of it, unless we change the framework really significantly. It means that the promotion of competition will have to come from, I believe, primary legislation in the main so that the regulators are obliged to act in ways that make it easier for customers and small businesses to get the services that they want at prices that are sensible.
Q171 Mark Garnier: So your silver bullet in the legislation would be to have competition as a primary mandate in both the FCA and the PRA?
Sir Donald Cruickshank: Yes, although I qualify that answer with what the relationship between these various bodies is going to be. Given cross-membership and the like, my preference would be to have both the PRA and the FCA with precisely the same competition objective and powers so that when they are asked to act together, they do so within the same framework vis-à-vis competition. Then, if there are real tensions between their other objectives, we have the FPC and the Bank itself moderating the answer.
Q172 Mark Garnier: On a slightly wider point about general competition in the market, it has been suggested by some people that one way of increasing competition would be to break up the big conglomerate banks that are owned by the state-Lloyds Banking Group and RBS. Do you think there is any mileage in that idea?
Sir Donald Cruickshank: In 2000, I was tempted by the US model of saying that no one institution can have more than 10% of deposit taking-it does not need to be 10%; it can be any number. I did not pursue that line then and I’m not sure that I would now either-de facto, that is what breaking them up would mean. There are ways in which the markets I am talking about can be made significantly more competitive and better, such as if the money transmission systems are regulated properly, without divestment or significant structural change.
Q173 Chair: Just on this point about whether the PRA and the FCA can have exactly the same objective on competition, do you not think that there is something to the Government’s argument that the PRA has a different overall task-the financial stability of the system as a whole-which ultimately should be permitted to trump competition, particularly in a crisis, and that the PRA needs the leeway to do that?
Sir Donald Cruickshank: In my answer, I talked about moderating-refereeing might have been a better word-tensions between what the FCA might want to do under that heading and the fact that the PRA, notwithstanding it having the same competition objective, was bringing to bear other arguments about stability. I believe the legislation has a refereeing rule which, in my view, would not necessarily stand in the PRA itself. I find it very difficult to imagine how this is going to work, to be honest
Chair: That is very optimistic, Sir Donald.
Q174 Mr Love: Earlier, you requested that we touch on switching-the ability of customers to change their bank. You said it was the key to competition and better consumer outcomes. Why is it so central?
Sir Donald Cruickshank: Because the person who is managing a division of a bank-or a region, or whatever-has got to worry on a Friday night that he might have lost a significant number of his customers by Monday because of something he did on Thursday night, such as if nobody could transfer money or get paid, which is the sort of stuff that happened to RBS customers, and went on for a month, I think, in Ulster. He or she has got to believe that there is a significant risk that, if that happens, a significant number of his or her customers will have gone by Monday morning. The only way to get to that is to make it as easy, or as close to as easy, to switch banks as it is to walk out of one supermarket and go to the next one. Now, we will never get quite there, but that is the key to the dynamic of competition in this marketplace for current accounts. The number of providers and the regulation of providers are of second order compared with the capacity of customers, particularly small business customers2. Most small business customers do not borrow money from the bank, not because they cannot get it, but because they do not want to. Most small businesses are happy to grow on the basis of internally generated funds, family contributions or whatever. So, as a whole, all consumers, plus a significant number of small businesses, would, or could, take advantage of better switching.
Q175 Mr Love: We are in a situation where the banks have never been more unpopular. People’s experience does not seem to be good at present, yet the level of switching has hardly changed and is at a very low level. How would you explain that? Is it the worry about switching or that there is no real demand there? Why are people so reluctant to switch bank accounts?
Sir Donald Cruickshank: It has a high transaction cost for the individual, to use the economist jargon. That cost is uncertain, because it may go as far as to erode, or make worse, your personal relationship with suppliers of goods and services, which frankly is a risk that you do not want to take. The process takes time and a bit of concentration. It is not made easy by your existing bank-notwithstanding the promises-and then there is the "Why bother; they’re all the same" argument. Until a significant number of people do change banks, and then at the pub, at home or at work they are able to say, "Yes, it is better," we will not get that dynamic in the market for current accounts which, in my view, would be the key to a better dynamic in other markets, whether that be for credit cards, lending or deposit taking.
Q176 Mr Love: I want to come back to the issue of cost, because that is one of the arguments used against this. Vickers accepted in his report the argument put by the industry that the seven-day switching process would be adequate and would increase the numbers. What is your view on that particular proposal?
Sir Donald Cruickshank: Around the world-not just in the UK-banks that provide services to retail customers are desperately trying to advance the argument that this is a cost, ultimately to be borne by the consumer, that is greater than the benefits that the consumer might reap in the longer term. They are obviously colluding, because with the submissions that they make in Australia, the UK or other countries, you can see that the language is exactly the same.
It reminds me of Vodafone, Cellnet and the others when I proposed number portability for mobile phones. They produced all these analyses for me about the cost, and I had sessions at which engineers came to tell me how impossible it was-not quite, because engineers never quite say that, but they said that it was all too difficult. Eventually, I got it through the Competition Commission and, within days, those same engineers were talking to my engineering team about how they were looking forward to it, and how they had this solution and that solution, and saying that it was one of the most interesting things they had been asked to do for years.
My prediction-and it is just a prediction-would be that we would find the same situation if we imposed this on British banks. You could hear the engineers clapping from here-they would love it. It would cost a lot of money, and it is not number portability on telephones-that was a simpler task. I do not know the detail, but neither does anybody else. The only people who have knowledge in this sector are the banks themselves. It therefore follows that there needs to be a dedicated regulator of money transmission systems with the resources to recruit the people, and the authority via some licensing regime to impose licence conditions on the money transmission system in particular, which is where most of the investment is, and on the licence holders-the banks-so that they adapt their systems in line with the underlying networks. That means primary legislation. It is option 3 of the current consultation.
Q177 Mr Love: I want to come back to the cost element, because we have had great difficulty getting any examples of costings for personal accounts from banks. It is a really difficult process. Is there any experience around the world? Do you have any knowledge of the impact that account portability would have? Switching levels are extremely low-much lower than they were in telecoms before number portability was introduced. What confidence can you give us that, if we resist the blandishments of the industry and say that we move directly to account portability, it will make a sizeable change in the numbers who will exercise their right?
Sir Donald Cruickshank: I have personal confidence, but that is not enough. I have not got the personal time or indeed resources to deploy. What I am recommending is that a regulator not unlike Ofcom, but with a much narrower remit, is established under legislation with a licensing regime. The model is network regulation elsewhere in the economy. The five years’ cost of that organisation would be not more than £100 million-and probably much less. If it concluded at the end of three or four years that there was indeed no case for number portability, that the costs outweighed the benefits, so be it. There would be amendments to the present regime, and on we would go with something different.
I am convinced that, for £100 million, that organisation would get something a lot better for the economy and for consumers than we have at present. It might not be number portability à la telecoms-probably not, actually. It will be something more complex, but simpler for the consumer. However, if we do not make that investment, we will never know, because the banks have the monopoly of the information here.
Q178 Mr Love: The industry says that it will be much more expensive than you are suggesting.
Sir Donald Cruickshank: No, no. The £100 million is the cost of the network regulator that would be tasked to come up with the best solution, which might or might not be portability, but at least we would know. It is not a big cost. Look at the scale of the financial services industry in the UK. Spending £100 million over five years on asking a group of experts with proper powers to regulate banking networks and some of these outcomes is, in my view, an investment well worth making.
Q179 Mr Love: It has been put to us that perhaps we should set a deadline, and that rather than saying it must be done immediately or that the process must be started now, we could say that within a time scale-five or 10 years-it should move towards that, and that would give them a chance, if they are upgrading their IT systems, to include this within them. Are you sympathetic to that, or do you think we should go for gold straight away?
Sir Donald Cruickshank: To be clear, I am recommending that we put in place an organisation under statute that is properly equipped with the powers to explore this and, indeed, other related issues, such as ATMs and credit card charges. There are a lot of issues that this regulator could set out to deal with, in addition to account portability. I am recommending that it would be in the interests of the economy to legislate for that, and to have that dialogue over a number of years between that regulator and the banks to determine what the best outcome is. That regulator’s decisions would be subject to the Competition Commission and subject to the courts. That is the way to go. Another decade gets us nowwhere.
Q180 Mr Love: Let me ask you one final question. You hinted at it in your reply. Are there other aspects of personal current accounts, about transparency, about people understanding the costs of their account and the benefits that they receive? Are there other things that we need to do to maximise people’s ability to make the right choices for themselves?
Sir Donald Cruickshank: A very good point. One of the things that I have not said is that it is my judgment that if we got closer to some account portability solution, it would erode free-in-credit banking and the transparency that we are all after would willy-nilly begin to emerge about the precise costs of what we were doing. It would begin to be clear that it would cost you £3 if you wanted to write a cheque, but 22p if you wanted to do a direct debit etc, etc.
Q181 Lord Turnbull: I want to follow up on portability. What is the specific licence condition that this new regulator would impose? I assume it is not simply saying, "Your seven days is not good enough, make it three days." There must be something else that you have in mind about how accounts are structured and managed so that they can be easily transferred.
Sir Donald Cruickshank: I don’t know the answer at an electronic engineering level. But the licence condition would read approximately that the licensee would be obliged within some time scale to provide some defined outcome. The outcome would be defined in terms of the consumer experience. Now, whether that would mean there would necessarily have to be something like an NHS number assigned to an individual, that detail is for the engineers within the regulator to negotiate with the banks. But that would be the framework of the licence condition.
Q182 Lord Turnbull: Do you think a lot of people do what my family does? They actually have several accounts with several different banks. If you are not satisfied, is not the solution what a lot of people have done and to open an account somewhere else? Opening and maintaining an account is free. Over time you switch more and more of your transactions through this second account.
Sir Donald Cruickshank: I am sure that there are families-I am one of them and you are one of them-who do just that. However that class of customer is taking advantage of cross-subsidies from other classes of customer. I don’t think that is healthy for the economy, even though it may be helpful to your family and mine.
Q183 Lord Turnbull: Maybe this comes on to free-in-credit, but I think Pat McFadden is going to deal with that. Oddly enough, a side benefit of this at the moment is that it makes switching easy. We all think that maybe there are some advantages in not having free-in-credit, but that would make switching more difficult. At the moment it is costless to have as many bank accounts as you want to have.
Sir Donald Cruickshank: Remember we are talking about small business here as well where that definitely does not work. If you are a small business trying to run multiple bank accounts, that makes you very suspicious to your main banker, particularly if you have a debt and have borrowed money from that main banker. We are dealing with a class of people that is wider than just consumers. We do not know and we do not have a mechanism for answering these questions, just as we used not to know anything about electricity generation or its pricing until we had network regulators. Now, on whether they have done a good job, I would argue, on balance, yes. What I am recommending is not a detailed solution; it is a principle that we should have a money transmission system regulator with sufficient powers to explore the real answers to these questions on our behalf. It would not cost all that much money, relative to the total benefit that we might procure. Waiting or accepting the assurances of the banks is not the right policy route.
Q184 Lord Turnbull: I can confirm that, only yesterday, a senior banker told me that this would cost billions.
Sir Donald Cruickshank: That is not a big number.
Lord Turnbull: I am actually confirming your view that that is what they would say.
Chair: They have been saying it for a long while.
Q185 Mr McFadden: I want to go on to free-in-credit banking. The first witness that who came before us was Sir David Walker, who thinks that this is a distortion and that it is an incentive to sell customers lots of stuff that they do not need and so on. On the other hand, we had Which? say to us that getting rid of it would be outrageous for the public, that it is not free anyway in that banks get to use the deposits and make money out of the capital, so they do benefit from it, and that they sting you when you are not in credit as well. You are familiar with the arguments. Just take us through your view on this.
Sir Donald Cruickshank: Notwithstanding that I used the phrase "free-in-credit" in response to Lord Turnbull’s question, it is not the phrase that I would use. A competitive market cannot sustain cross-subsidies between one class of customer and another, so if we have a competitive marketplace, these cross-subsidies will begin to erode and we will end up with, I believe, a simpler relationship between banks and their customers with transparency in pricing. There will be the opportunity for individuals to really think about whether they want to keep writing cheques or whether they want to learn how to transfer money electronically and so on. At the moment, there is no incentive towards efficiency in the system as a whole. It is not free-in-credit. A competitive marketplace cannot sustain cross-subsidies between one class of customer and another. That is actually a good test of whether we have a competitive system, because cross-subsidies being sustained over many decades means that we do not.
So, do you want what the consequences might be? It would take time for the cross-subsides to unwind. It would take time for the transparency and the consequent simplicity to develop, but I believe that in the end it would be good for the economy and for almost all consumers. It would also make it easier for the million people who do not have a bank account to get one, which is incidentally one of the other benefits of having a money transmission regulator, because that person could oblige banks to provide a basic bank account to anyone who wants one.
Q186 Mr McFadden: Why would charging for them make it easier for people who currently do not have bank accounts to get one?
Sir Donald Cruickshank: Because there are ways of running a bank account where the costs are trivial. That is usually called a basic bank account. It means you or your employer or the state, via benefit arrangements, can deposit money. There is no possibility of you going overdrawn. You can only extract money via one debit card, etc.
Q187 Mr McFadden: I understand that, but these are people who are on really tight budgets. If you said to them, "We can give you this service, but it will cost you £5 or £10 a month," do you think that they are likely to take it up?
Sir Donald Cruickshank: Nothing like that. I imagine there being one deposit and then five or 10 cash withdrawals a month using an ATM and a few other transactions. There would be no cheques. They could eventually build up to maybe using other bank services, but that would be their choice. What are we talking about? We are talking about £1 a month.
Q188 Mr McFadden: On the broader current account market, how grateful do you think the public would be to a Commission like this, set up in response to an interest rate fixing scandal where people were offering bottles of Bollinger to one another, if one of its principal recommendations was that something we currently get free should be paid for? These packaged accounts do cost £10 to £15 a month. On a scale of one to 10, how grateful do you think they would be?
Sir Donald Cruickshank: We have not talked about standards. I understand that I am here to talk about competition. However, that is a very good question. I have argued in response to the first questions from the Chair that I think more effective competition would improve standards for the consumers in the markets I defined. It would be a consequence that we would need to put in place a regulator of money transmission systems.
The consequence of that would be that what you are calling free-in-credit banking would erode away. The costs of banking would become more transparent. That would mean some people end up paying more and some less. That is the logic to it. But you do not need to mention free-in-credit in your report. You could just go for putting in place the regulator and let that regulator get to work and let the Competition Commission and the courts if necessary moderate that regulator’s behaviour.
Q189 Mr McFadden: I am not quite sure that is how the world works. I think if we gave such a signal it would be seen as quite a big part of our final recommendations if we were ever to do that.
May I ask you about one other thing in a slightly different area that you mentioned briefly that we have not followed up on? You mentioned civil and criminal penalties. That is also something that concerns the public. When something goes wrong, such as the LIBOR thing or others that have blown up, what tends to happen is that the institutions get a fine that can look large in terms of the initial sum of money but, compared with the profits they make every year or their turnover, can actually be absorbed by them as the cost of doing business. It is very rare that individuals get fired, punished, sent to jail or whatever. What would be the policy change for a Commission such as this to change that and to make civil and criminal penalties for individuals more likely?
Sir Donald Cruickshank: I address that at a very high level in my paper. I said that we would need to legislate for what I called a financial corrupt practices Act. The model I had in mind was the Foreign Corrupt Practices Act of the US. The reason that I had that in mind is because I am a member of the audit committee of a large American company, and I understand a model of operation in which members of that audit committee are held to a higher standard than the other directors of the company and are potentially subject to civil and criminal proceedings against us. It does not half change your behaviour.
Q190 Mr McFadden: So what would your proposed Act do? I am trying to tease out in simple terms what your Act would mean. How would it change things?
Sir Donald Cruickshank: I have done some notes on it. It would identify the definition of executives, which would include directors but would go wider than that, within an entity that is licensed to take deposits and carry out banking activities. It would say to that group of people, "Thou shalt not do x, y and z." In other words, it would define corrupt practices in a way that was relevant to banking. Again, this is not doctors or medicine. It would clearly set out the penalties for being found guilty of offending that Act. The American Act is policed by the DOJ and the SEC. I am not sure that we have an equivalent: the Serious Fraud Office, I suppose-and that is being renamed, isn’t it?-and the FCA. Broadly, these two organisations would take a view as a case developed as to whether to pursue criminal proceedings, in which case the SFO would take it on, or civil proceedings, in which case the FCA would take it on. The legislation would be aimed at individuals, particularly the set of individuals at the top of an institution, and, in particular, those sitting on audit, risk or governance committees. It would be quite explicit that they would be held to higher standards.
Mr McFadden: Your note to us was admirably brief, but if you wanted to expand on that point, and give us a supplementary on that specific issue, I would certainly find it useful.
Q191 Lord Turnbull: Just to clarify: is your requirement solely for banks and financial services or is this a general application?
Sir Donald Cruickshank: This comes under my principle that this sector of the economy demands exceptional and harsher rules than the rest of the economy. You are right that in the States, it’s everybody. I am suggesting that that is disproportionate, but that for banking in the UK it would be a proportionate model.
Q192 Mr Love: Can I take you back to your response on basic bank accounts? For many people with basic bank accounts, there is a limit to the benefits that competition can bring. Services are being taken away from holders of basic bank accounts. You mentioned the regulator for financial interaction. Can you expand on that, and on how you think a regulator could assist people with a basic bank account?
Sir Donald Cruickshank: One of the powers the regulator that I have in mind would have would be relative to pricing. In other words, if it was deemed that lack of competition was producingcost-based pricing, they could intervene and say, for instance, that, for the purposes of charging somebody with a basic bank account, the cost of a direct debit can only be 9p, or whatever the real number is-they keep saying 23p or 24p, but I doubt that. The powers of this regulator would be not unakin to what the water regulator or telecoms regulator used to have, with a capacity to regulate the costs of the network as they are being charged to consumers.
Q193 Mr Love: We got regular reports, when we did an investigation, about banks being very reluctant to sign up new basic bank account holders, the argument being that they are not profitable. How would the regulator deal with that issue if they got complaints from customers who were being refused basic bank accounts?
Sir Donald Cruickshank: Let’s step back. I am not suggesting that the regulator could impose on banks an obligation to bank the unbanked. However, the regulator could impose on banks an obligation to price their services such that it was easier for the unbanked to have a bank account. They would do that by, if necessary, pricing the cost of a direct debit or an ATM transaction or whatever in a way that reflected the real costs of doing the business, not the bank’s assessment of that cost.
Q194 Baroness Kramer: If I could take the conversation back to SMEs and explore the relationship between SMEs and the current banking structure a little: I do not want to put words into your mouth, but I interpreted what you said earlier as, "Even a highly concentrated system can, if appropriately regulated, provide a competitive environment," although I think you did not particularly wish to support a system that entrenched a highly concentrated environment. Is that a fair reflection?
Sir Donald Cruickshank: Yes.
Q195 Baroness Kramer: I wanted to pursue that a little bit more, because we have had plenty of evidence, which you will have seen, to suggest that the market for credit to SMEs is perhaps almost the most concentrated of all within the banking sector. It is dominated by four banks, which provide approximately 80% of the banking services. Why, in your analysis, is it so particularly concentrated for that part of the market?
Sir Donald Cruickshank: Because it is very risky. That is something people seem to have forgotten. Lord Turnbull will know better than I, but a number of the post-war banking crises have been a product of banks losing a lot of money on small business lending. It is actually quite risky, and hence the infrastructure that the bank has to put in place to manage that risk, and to have enough information about the individuals and the firms to whom they are lending, is quite considerable. Given the fact that it is a risky activity, which demands a large investment in infrastructure-mainly people, but systems as well-it does not surprise me that that would tend towards being quite concentrated.
Q196 Baroness Kramer: Would you consider it a fair analysis to say that because it is so concentrated, and because it is a risky part of the business, in effect the major banks that are currently providing those services no longer have in place a system that enables them to give the kind of customised analysis that one would think was the most appropriate in a high-risk situation? For example, the banks have withdrawn to credit scoring for relatively small loans-say, anything under £150,000-which is a very blunt instrument in terms of identifying the risky customer from the safe one-or the bankable customer from the unbankable one, if you like. We have got, therefore, a bit of a market failure in that area, partly as a result of that.
Sir Donald Cruickshank: This market failure in the provision of finance to small business is often, in my view, a market failure in the provision of risk capital, and this tension between the banks and small business is often about perception. The individual or the small firm thinks that it is absolutely reasonable for the bank to lend money for some expansion or some development of the business, or indeed to keep it going, and they ask the bank to take that risk. The bank thinks, "No, that is not our role. That is risk capital you are after. We used to have a subsidiary that would deal with you but we no longer do, but there are people out there who will help you."
A lot of this argument about market failure is about different expectations and assessment of risk. The small business owner is absolutely secure in his or her mind about their business, what they want to do and how they want to develop, but the bank is not. The bank thinks, "What you want to do demands risk capital. Get it from your family or from somebody else; we are not going to lend it to you." It is not that they do not have money to lend, even now, I believe. What I have just summarised has been the conclusion of report after report over the previous three or four decades. That may be exacerbated right now, because banks’ balance sheets are shrinking and, actually, it is quite a risky time to be lending to small business, but I do not think that that is new. It is being exacerbated by the dwindling of the banks’ balance sheets, but I do not think it is a new issue.
Q197 Baroness Kramer: Let me follow on a little bit. Other countries deal with that problem in a different way. Obviously, in Germany the Sparkassen are very much focused on small businesses, and I do not think it would be an exaggeration to say that many of the unbankable credits, in the view of banks in this country, would be ideal customers and would be seen as highly bankable by the Sparkassen. In the United States, community development banks serve pretty much the same market and provide a backbone to the small business industry. In this country, of course, the new agreement between the banks and our very tiny CDFI sector is that they will refer customers who are rejected to CDFIs, which are beginning to demonstrate that, indeed, they are quite capable of lending to those institutions that have been rejected without the kind of failure rates that the banks themselves would have predicted. Are we in a situation where this concentration is blocking out the kind of players, which other countries have, who are capable of serving this industry?
Sir Donald Cruickshank: It is my observation, although I am not quite up to speed as it sounds as if you are, that all those institutions are either explicitly or de facto backed by the state and do not actually take the risks that we are asking RBS and the others to take if they lend to small businesses. In other words, by and large, they are capable of sustaining losses or taking views on risk that are different from an organisation that has shareholders and a return on equity to deliver. I think having parallel institutions in the UK would be a good idea. Indeed, that is one of the things I recommended. My focus was on the US. I know little about the rest of Europe. The essence is that the cost of capital for these institutions is less than it would be on the open market. Therefore, they are capable of lending at better rates or taking higher risks, depending on the balance they choose.
Q198 Baroness Kramer: I would take issue with your assumption that they have higher failure rates, because I do not think that is sustainable in the face of the various surveys that have been done. I would challenge that, but it is interesting. In terms of generating the kind of institutions that you talked about, are there mechanisms in the competition structure that could open the door to development of that sector? I am going back again to the kind of terms that define the responsibilities of, say, the PRA. Would change at that level create the opportunity for the development of such structures?
Sir Donald Cruickshank: That is not something I have had a chance to think about. Notwithstanding that as I get older I sometimes talk off the top of my head, that is not an area I would be prepared even to speculate on here. Your question reminds me that, in my original report, I argued that banking markets for SMEs were local, not national, and that there were regions or local areas in the country where the concentration is such that something should be done. The Competition Commission said, "No, the market for small business banking is national and, therefore, the concentration is not an issue." That is perhaps an elaboration of the answer I gave to a previous question.
Q199 Baroness Kramer: That is very helpful. I have one final question, if I may. A lot of the feedback from small businesses is not just that they cannot get credit, but that even when they apply, the service quality is exceedingly poor, with long delays in getting responses. Do you see competition as the key mechanism for changing that particular profile?
Sir Donald Cruickshank: Both competition and, oddly enough, the regulator I keep advancing for money transmission systems. A lot of small businesses handle lots of cash and cheques, and are effectively tied to providers locally. Once a small business is tied to one bank, it is difficult to get lending from another bank and have financial activities in another bank.
One of the things that would help enormously would be an obligation on any bank to accept any small business’s cash, cheques and so on for the right cost, so that a small business was not tied to his or her local bank for lending or more sophisticated services-foreign currency or whatever it might be. That division would be very helpful for-not the smallest of businesses- but businesses that have the capacity and someone who is looking after the money, if not a finance director. When you get to that scale, the way in which the money transmission system is regulated could free the small business from that devotion to the local bank. It would be very helpful.
Q200 Lord Turnbull: In your admirably punchy-characteristically punchy-note, you say, "Ensure that Vickers is not diluted further". Does that mean that you, personally, would want it to go further but, as a minimum, we shouldn’t go back, or are you satisfied with where he has drawn the line and, therefore, that must be protected?
Sir Donald Cruickshank: To be honest, I wrote that after reading a transcript of Mr Volcker’s evidence, which is in front of you. There is provision in the Bill for the Government to lay secondary legislation addressing new exceptions. It is very open wording to my mind, and I think that Vickers-or the banking reform Bill, to be precise-is fine as it stands, except for this provision, which could allow dilution over time. Let us be clear: this is something that banks will eat away at systematically and very strongly.
Q201 Lord Turnbull: You are not making a fundamental objection to the use of subsidiaries?
Sir Donald Cruickshank: No. My anxiety is about the capacity of people to persuade the Treasury to let something erode. It might be for a good reason, but-
Q202 Lord Turnbull: Just one other observation, you argued that greater competition could improve standards. One of the things that we have to do is look the HBOS history. It was a group that portrayed itself as the fifth force. What did it do? It actually behaved pretty badly in the sense of taking the philosophy of making money by selling to customers rather than serving them and, thereby, making money. I therefore wonder whether some of the new entrants in a hurry to catch up with more established players actually cut some corners.
Sir Donald Cruickshank: That is why I mentioned Trollope in my introduction and The Way We Live Now. New entrants will perforce be obliged to take upon themselves the standards of the incumbents. Let us deal with the incumbents properly. We can then be reasonably content that new entrants will have to behave themselves. The Trollope reference is to Trollope coming back from years abroad to find a city-London-wrapped in greed. It was the precursor to the great depression, as it was then called. His book is about the behaviour of not just the City but Westminster, interestingly, and the general drift in standards that had taken place. There is a little bit of that, I think.
I do not think that bankers are any worse than they have been in the past. They always calibrate off society. They are always worse. When society moves, the bankers get worse. I noticed that David Walker made exactly the same point, and I agree. We have been here before and it is important not to overreact. Basel III and Brussels might be overreacting. It is important that you as a commission take a wise perspective on all this and deal with the issues that can be dealt with and, in particular, do not recommend anything that would harm the financial services in the City and the UK, because it is a very important part of our economy and our lives.
Chair: The Melmottes, they come and go, and there is a cycle to standards and we are also taking evidence on that. We are grateful for your guidance on that point, which we very much take on board. Andy Love had one very last question.
Q203 Mr Love: It picks up the last point you made about the City of London because in your statement, you call for exceptional regulation. You list some of the areas that would be covered by that, and you also say, "Don’t do anything to weaken the UK’s competitive position." Do you see any tension between those two? If we call for this, the accusation that we will have from the industry will be, "You’re making it more difficult for us to compete."
Sir Donald Cruickshank: Yes.
Chair: That is very helpful.
Sir Donald Cruickshank: I would only add-this goes to my US experience, although maybe the US is different from the UK; it can be exceptional-that the US manages it in a whole number of areas, and I am sure Europe could; maybe not the UK, but Europe could.
Q204 Chair: Thank you very much for giving evidence. It has been tremendous again to hear what you have to say. The Treasury Committee has always found it helpful, and we have found it helpful this morning. We are very grateful to you, too, for agreeing to send us a few more odds and ends in response to a number of questions.
Sir Donald Cruickshank: I have two.
Q205 Chair: You have two. That is correct.
Sir Donald Cruickshank: I have the competition objective and the Financial Corrupt Practices Act to write.
Chair: Thank you very much indeed.
 Witness correction: meant to say “..have a modest change, or have something” instead of “I think there are three versions, the last of which would ”
 Witness correction: meant to insert “, to change banks.”