CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-xxxviii

HOUSE OF COMMONS

HOUSE OF LORDS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

BANKING STANDARDS

MONDAY 25 FEBRUARY 2013

RT HON GEORGE OSBORNE MP and JOHN KINGMAN

Evidence heard in Public

Questions 4304 - 4408

USE OF THE TRANSCRIPT

1.    

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 Committee, and copies have been made available by the Vote Office for the use of Members and others.

2.

The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Joint Committee

on Monday 25 February 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

The Archbishop of Canterbury also attended as a Specialist Adviser with power to examine witnesses.

Examination of Witnesses

Witnesses: Rt Hon George Osborne MP, Chancellor of the Exchequer, and John Kingman, Second Permanent Secretary, HM Treasury, gave evidence.

Q4304 Chair: Good afternoon, Chancellor. Thank you very much for coming before us this afternoon. We are doubly grateful, bearing in mind that you have already had an hour and a quarter or so on the Floor of the House with an urgent question on the Moody’s downgrade.

May I begin by asking you what contribution you think the dysfunctionality of the banking system is making to sluggish economic growth at the moment?

Mr Osborne: First, thank you for inviting me along, and I should introduce John Kingman, who is one of the permanent secretaries at the Treasury and has responsibility for financial services.

The short answer to your question is that I think that the impairment of the financial system has had a significant impact on the UK’s economic recovery. We are not unique in the world in experiencing that problem, but the impairment of the credit channel, including through our major banks, has been a drag on recovery. It is one of the reasons why, for example, with the Bank of England, we created the funding for lending scheme. That is not a normal intervention in a recovery, but it was required because of the losses on the balance sheets of the banks. To be fair, the two most impaired banks-Royal Bank of Scotland and Lloyds, because of the takeover of HBOS-are making substantial progress in reducing those impaired assets and non-core assets, but there is no doubt that our recovery from this financial crisis, this balance sheet recession, has been much more difficult than recoveries from more classic recessions. Indeed, it has pretty much followed the prognosis that people such as Ken Rogoff have set out for us.

Q4305 Chair: And that is because of the dysfunctionality of the banking system.

Mr Osborne: When you say dysfunctionality, it depends how you define that. I would say that it is the impairments, the bad loans sitting on balance sheets, the general reluctance-here, I would talk not specifically about the UK, but in the global banking system-of banks to recognise losses, which has meant that credit allocation has not been as efficient as it might otherwise have been.

Q4306 Chair: Okay. When you put to the House of Commons the suggestion that there be this Banking Commission, we were doing that in the wake of the Barclays LIBOR scandal. Since then, we have had a succession of further scandals-most people would agree-even more serious. Just how bad do you think this problem of standards in banking is now? Do you think that, even though you felt it necessary to create a Commission to look into it, that if anything you were underrating it at the time you created this Commission?

Mr Osborne: I think the LIBOR scandal-obviously, it revealed itself first with the FSA report into Barclays-spoke to a wider problem in the industry than simply the manipulation of the LIBOR rate. In one sense, we have addressed the manipulation of the LIBOR rate, I would argue, through the work that Martin Wheatley has done and the regulations we have brought in better to regulate-indeed, to regulate for the first time-that market.

Why was there such a powerful reaction to that report? I think that it spoke to an anger out there in the country at the standards, culture and practices in parts of our banking industry. I must say, right from the beginning, that there are many hundreds of thousands of people who work in this industry across the entire country-many of them are of course extremely diligent, ethical people-and it is our country’s most important industry in terms of the number of people that it employs, so we should not tar everyone with the same brush. But it was clear that practices and cultures have been allowed to develop that went beyond the wrongdoing of specific individuals.

I felt, looking at what we had done as a Government, that we had sought to address the failure of regulation through putting the Bank of England in charge of prudential regulation; that we had sought to address the "too big to fail" problem through the Vickers report and then the banking legislation, which is coming through Parliament now; and that we had sought to address that desire for the bankers to pay something, through the bank levy-but I do not think that we had all the answers to the question of what to do about the culture and ethics of the industry.

What is striking-I am sure that Members of both Houses have had this experience-is that the hostility is often felt greatest among the rest of the business community. The anger is felt greatest among the rest of the business community, so it is not a classic ideological argument between left and right or between free enterprise and socialism, to put it in its old-fashioned context. Actually, you usually find a small business audience is the most hostile to the culture, ethics and practices that grew up in the banking industry. They feel that it is deeply wrong that when their business fails, they go out of business, but when a bank fails, it is bailed out. They think it is deeply wrong that LIBOR rates are manipulated and people are rewarded, and so on.

That is why it is so important-I do care about this industry, and I think it is a very important industry for the UK and, indeed, for our economy-that we get this right and that we improve these standards, ethics and culture, precisely so that we can have a flourishing, successful, competitive financial services industry.

Q4307 Chair: And you would agree that the problem appears to be worse now than at the time you created us?

Mr Osborne: I am not sure that the problem has got worse-

Q4308 Chair: Our perception of the problem has been informed by more scandal.

Mr Osborne: To be fair to the industry, the leaders of the industry are among the first to recognise the problem. Secondly, a lot of what we are discovering are things that went wrong in the past: the LIBOR manipulation, the mis-selling of interest swaps and the like. So I am not sure it is a growing problem. Perhaps we are seeing more of the problem than we previously saw.

Q4309 Mr McFadden: Chancellor, in our report published just before Christmas, with regard to structural separation, we made recommendations for two reserve powers to go into the Banking Bill. The first was a reserve power with respect to individual banks: they could be broken up if they were trying to game the ring fence or get round the rules. The second, on the basis of an independent review, was a reserve power that could apply to the sector as a whole. In your JP Morgan speech a few weeks ago you accepted the first reserve power but not the second. Could you tell us why you rejected the second reserve power applying to the sector as a whole?

Mr Osborne: The first thing I can say is that I thought about this quite deeply. I did not lightly turn down one of your recommendations. Of course, it is in the context of having accepted the bank-specific power we are giving the regulator to break that bank up if they are flouting the rules and not ring-fencing themselves in the way that has been intended by the law. That is a pretty powerful new tool that the regulator has-the most powerful tool it probably has. That, I think, meets your demand that the ring fence be electrified.

On that second issue of whether you have a sector-wide power in this legislation, the short answer is I think it would be rather undemocratic. There is an irony here. When I came before you previously you asked me all about the secondary legislation and why more of the content was not on the face of the Bill. I would say that to hand to a Government, even to a Parliament, a simple power to break up the entire banking system, without having to go through the hard work of primary legislation, is a mistake. If a future Government wants to do that, if it feels that the Vickers reforms have completely failed, then it should go to Parliament with primary legislation so it can be properly debated, in the way that the Vickers reforms have been and are being, in order to bring about that complete separation of the industry.

That was my primary motivation. There is a second motivation, which is the one that Mervyn King, who has been quite a strong advocate of structural reform of the banks, gave to this Committee. He said that it would be like a sword of Damocles hanging over the industry. He meant that in a bad way. I will defer to the Archbishop about the precise biblical allusion to swords-

The Archbishop of Canterbury: I think it is a Greek myth.

Chair: Dionysius of Syracuse.

The Archbishop of Canterbury: Not my branch.

Mr Osborne: It was all a long time ago, anyway. To have hanging over the industry this power that could be activated by secondary legislation, even if you had some checks and votes in Parliament, would create some instability. I do not really see what it provides beyond the very important power you ask for which is the ability of a regulator to break up a banking group that is not complying with the rules.

Q4310 Mr McFadden: We thought it was important because banking problems do not just arise at the level of the individual institution. The experience of the crisis showed us that. You had problems throughout the sector. I don’t understand why, having accepted the logic of electrification, in the jargon, to make sure that the banks do what you want them to do anyway-what the legislation proposes they do-you resist taking that power for the sector as a whole. It is the sector as whole, as well as its individual institutions, that can lead to problems, as happened a few years ago.

Mr Osborne: I would say that there is a material difference. We have come up with a set of structural reforms that we have proposed to Parliament. I am not going make presumptions about Parliament’s judgment, but I certainly hope that it will accept the reforms. They include a new structural arrangement for the banking industry built out of two years of trying to secure a consensus, then pre-legislative scrutiny, and we now have the legislation itself. We have a new set of rules, which are those that the industry should operate on. That provides the platform or the stability for the industry going forward. If a bank breaks those rules, there is now a clear threat that it will be broken up. That is materially different from suggesting that you could create an entirely new structure off the back of a regulator and one vote in each House. That would be junking what we have and moving to a new state of affairs. If another Government, or this Government at some future point, ever wanted to do that, they should come to Parliament and make their argument and pass primary legislation.

When John Vickers came before you, he said that a sector-wide power-he was all in favour of a specific regulator power that electrified the ring fence-would actually undermine the ring fence, because people would always be looking for the moment that the regulators and the body politic moved on to the new system. I think it is better that we have a system. We have to make it work, and we have powerful sanctions for anyone who breaks the system.

Q4311 Mr McFadden: Both of these powers are not things that we expect the Government would have to use except in circumstances where the banks were trying to get round the primary intention of the Bill, which is the Vickers ring-fence separation. There is probably not much point in my asking you the same question another three or four times, but I do not accept the logic that these are materially different. Having accepted the logic of a kind of keep-them-honest power with regard to individual banks, I cannot speak for the rest of the Commission, but in our first report we thought the same logic should apply to the sector as a whole.

Mr Osborne: The only thing I would add is that, in your conclusions, the power for a regulator to break up a specific bank actually won pretty broad support. So that obviously means support from the Government, but also from the Governor of the Bank of England and from John Vickers. In other words, your proposal was broadly welcomed and supported. Your second proposal has not received that consensus support. Mervyn King has asked questions about it and so have John Vickers and others.

I would say that one of the advantages of what we are doing in the UK is that we are moving by consensus. Not everyone in the industry likes what we are doing, but the vast majority of people actually do support what we are doing. It is largely bipartisan and largely agreed between the two Chambers of Parliament. It is agreed by those who think deeply about such issues. There are, of course, exceptions to that, but we broadly have a consensus. There was a consensus view that your first recommendation-the bank-specific one-was a good one. Your second recommendation did not command such support. If we can maintain that consensus, that would be a good thing.

Mr McFadden: We may return to this. I should just say for the record that this is a power that we see very much resting in the final stage in the hands of the Government of the day and not regulators, precisely because it would be such a big decision to make.

Chair: Pat, before you come off that, I want to develop some of the points that you made in your answer, Chancellor. First, although it is true that the Governor has expressed some reservations about having this power in the hands of the regulator, it is also true that he advocated having an independent review after an interval. There are two stages to this process. One is that there would be an independent review after a number of years to assess whether full structural separation is necessary. The second stage would be, as Pat McFadden has pointed out, a process that would enable the Treasury to block the regulator’s preference for separation. Let’s just deal with the first of those. Why are you against having an independent review?

Mr Osborne: I am not against having an independent review. I am against-that makes it sound much stronger than I feel. I don’t think the way you proposed the review is the right way. I think what you just said was, "Let’s have a review about whether we need to move to full separation." I think we should have a review about whether the John Vickers reforms are working.

Q4312 Chair: Yes.

Mr Osborne: I am very happy to consider that.

Q4313 Chair: And that that may include a conclusion that we should move to full separation.

Mr Osborne: Let’s not prejudge this future review. We are setting up these major structural changes. There will, of course, be some unforeseen consequences of that regulatory change, as there always are of any regulatory change. The industry will adapt to it, hopefully in a positive way, but possibly in a negative way. I am happy to consider with you when would be the best moment to reflect on how the reforms have bedded in and how the industry has changed, possibly for reasons nothing to do with Vickers but all the other things happening in the industry, and see how the Vickers reforms are working.

I would not want the essay question to be, "Should we move to full separation or not?" The essay question should be, "Is the Vickers reform doing what we want it to do?"

Q4314 Chair: And the review should be independent?

Mr Osborne: It depends what you mean by independent.

Q4315 Chair: We set that out in the report. We said that it should be conducted by a person or group of people appointed by the regulator with the agreement of the Treasury Committee.

Mr Osborne: Ah well, I think the Treasury must have some role in picking these people, or at least agreeing to them. That is a matter of detail.

Chair: A matter of detail.

Q4316 Mr McFadden: Let me move on to another area, Chancellor, which is that of bail-in powers. I think we are both agreed that having bail-in powers, so that in future if a bank goes bust it is the bondholders and those to whom the bank owes money who bear the cost, rather than the taxpayer, is a desirable outcome. That is part of the Vickers review and the international discussion of these things. You have chosen to pursue that through the European recovery and resolution directive rather than to take powers to do that at a UK level. Again in our first report, we said there should be powers in the Banking Bill to do that at a UK level. Given the experience of the UK taxpayer and the uncertainty of getting agreement on these things among the 27 member states, why not take reserve powers in case the European route does not work?

Mr Osborne: I think we will know fairly soon in Europe if we are not getting what we wanted. I have to say that I have detected no great disagreement among the members of the European Union on the Recovery and Resolution Directive. There is a dispute among member states at the moment about whether you have a pre-funded fund to help bail out a bank. I would say that is second order to the main issue, which is how you go about recovery and resolution.

I think it is superfluous. It is a European industry and much of it is governed now by European law, since we have this directive going through. We have detected no great opposition to that directive. I think, from memory, that you accepted that the directive, if it passes in its current shape, is sufficient. I don’t think there is any need. I am again happy, if during the course of the year that changes, to revisit the issue, but I don’t think it is necessary now.

Q4317 Mr McFadden: So you are telling us that you are highly confident that there will be a bail-in mechanism adopted in the near future that the UK Government are satisfied with.

Mr Osborne: I am saying that we are pretty confident that is the case. I think that is also the view of the regulators.

Q4318 Mr McFadden: Do you accept that, given the size of the banking industry relative to the UK economy, there is a particular responsibility on us here to ensure that the taxpayer is not on the hook for future failures in the way that they were four or five years ago?

Mr Osborne: There is certainly a heavy responsibility. I am not sure that if you spoke to the Finance Ministers of other countries they would not also feel quite a heavy responsibility. What is particular about the UK’s situation is, first, the size of our banking sector relative to our GDP. Obviously, countries with larger banking sectors relative to their GDP, such as Iceland, Ireland and, as we speak, Cyprus, have had a very difficult time-even more difficult than we had in 2008.

Secondly, we also have a responsibility as a global centre. We are currently ranked as the pre-eminent global centre of finance, so we have a systemic role in the world economy, which is one of the reasons why we have to have very, very good regulation here. I think we are just disagreeing about the vehicle for doing that. We are very happy with the European directive in the areas of recovery and resolution. We have one or two issues with the bail-out fund, but I would not say that is material to the issues with which this Commission is concerned.

Q4319 Mr McFadden: Is it not a bit curious to be pursuing this through a European directive when we are putting our membership of the European Union in question through a referendum?

Mr Osborne: I am not sure I accept the link between the two. We are putting the Basel agreement into law through the European Union and the CRD IV directive. Our regulation of our derivatives market is done through European law, and our regulation of our hedge funds is done through European law. I think this is one of the many issues that would face us were this country to vote to leave the European Union.

Mr McFadden: That’s my point.

Chair: We have to move on.

Q4320 Lord Turnbull: When we are dealing with electrification, we are dealing with an issue on which the Commission has gone further than the ICB. The leverage ratio is slightly different, and it is one of the few cases where the ICB made a proposal that you have not accepted, but we backed them and continue to do so. You accepted the increase in the risk-weighted assets ratio from 8.5% to 10%, in which you went above the Basel minimum, so why are you not prepared to go above the Basel minimum for the back-stop ratio, which would then go up from 3% to 4%?

Mr Osborne: I should first make it clear that I strongly support a robust leverage ratio. We were just talking about the European Union, and I think the UK has been the leading proponent of implementing a leverage ratio through European law. We are currently arguing for the 3% leverage ratio agreed to by the Basel committee to be implemented across the European Union. Indeed, we have made some progress on that.

Our concern about the 4% ratio has been that, instead of the leverage ratio being a back-stop, it would suddenly become a bit of a front-stop for a number of our institutions. In other words, the ratio would be the first thing that bites, rather than acting as a back-stop. John Vickers and his Committee made it very clear that they envisage the leverage ratio as a back-stop power, rather than a front-stop in regulation.

You have had submissions from people, such as Nationwide, who are very concerned about the impact of the 4% leverage ratio on their business model. There are some banks that, frankly, we would regard as engaging in less risky activity than other banks but that would be more affected by a leverage ratio, which seems a bit perverse. We have a reasonable compromise, which is that we are trying to get-indeed, we are succeeding in getting-a 3% leverage ratio implemented at a European level. Our commitment to the Financial Policy Committee has been to give them a leverage tool by 2018-subject to a review in 2017, so there is a caveat-but, in other words, not to proceed so far ahead of the European pack that we are not even getting the European rules agreed before we are implementing our own rules. So, having thought about it and having looked at the impact on a number of building societies and banks, our feeling was that it would become the front-stop rather than the back-stop, and, as I said, I am a big supporter of the leverage ratio but it should act as a back-stop.

Q4321 Lord Turnbull: I am not sure that I agree with this front-stop and back-stop problem. If you bring it down and some institutions start being affected by it, one conclusion is that we shouldn’t bring it down any more; the other is that maybe those institutions still have too high a ratio and therefore it is a warning sign that they should be rethinking their position. Historically, before the expansion in the last decade, British banks had a ratio of between 20 and 25. Then it shot up to something like 40: people will recognise that that is probably too much. Bringing it down to 33, just because some people have positioned themselves at this high level, tells us that maybe you are not taking it down far enough. Maybe the problem is not that the leverage ratio is too fierce but that there are still people around who have ratios that are too high.

Mr Osborne: We are again arguing about the difference between a 3% ratio and a 4% ratio rather than the concept of a ratio at all, and it is important to put the debate in that context. I was struck by two things. First of all, the point that both John Vickers’s commission and Andrew Bailey, the new deputy governor of the Bank, made to you in their hearings with you was that the leverage ratio should be that back-stop. Then, at the same time and alongside that, there is evidence from the industry that for some institutions it would act really as the first bite on them, and not as a back-stop. For example, in written evidence-to the Treasury Committee in the House of Commons rather than to your Commission-the Nationwide, which I don’t think that most people would regard as the most risky business in the financial services industry, said: "A leverage ratio over and above Basel III is wholly inappropriate for low-risk institutions and could create significant unintended consequences for consumers and the wider economy." Now, I am not accepting that at face value. What I am saying is, let us examine over the coming years-and we are only talking, as I say, between now and 2017-the impact on our domestic industry of going beyond the European leverage ratio; let us see what impact it would have on building societies in particular, but also on other institutions such as, for example, banks that are heavily deposit-funded; let us examine that. As I say, I have made a commitment to give this leverage power to the Financial Policy Committee; I just think it is reasonable, before you impose this on the industry, to see how it would play out, particularly when you have warnings from lower risk institutions that it would have a disproportionate impact on them.

Q4322 Lord Turnbull: The thing you should not take at face value is that something that was a building society is the kind of building society it always used to be. In that case, maybe this thing would be too rigorous for them, but if they have diversified into commercial real estate and other forms of financial assets, or if they have gone into the racier kind of mortgages, maybe we shouldn’t be treating them as though they were low risk lenders. I don’t think you should accept at face value the story that those institutions are simply the good old building societies we used to know, because they have diversified their lending as well.

Mr Osborne: The industry is, of course, constantly evolving and changing. A higher leverage ratio could have the perverse effect of actually forcing banks and building societies to adopt slightly riskier models of funding in order to comply with the leverage ratio. As I say, what I am proposing is some caution before we rush to impose unilaterally on the UK a higher leverage ratio than the ratio recommended by Basel. By the way, it is not as if the rest of the world has leapt to adopt the Basel recommendations, so let us at least get the horse before the cart and get the Basel 3% agreed and then get the-

Q4323 Lord Turnbull: But in other spheres you have been prepared to have more exacting requirements than Basel, regarding them as a minimum, so why?

Mr Osborne: Because I think that the evidence that the Treasury has seen about the impact of the higher leverage ratio and the unintended damage that it might have is more compelling than the representations we received from the industry on lots of other areas where we have gone beyond Basel.

Q4324 Lord Turnbull: Even though these ratios are still significantly higher than they were pre-financial crisis?

Mr Osborne: I am sure we could find a way of doing this that did not infringe on the commercial confidentiality of some of the firms, so maybe it would be helpful if we could share privately with the Commission what some of these institutions-when you hear or see their names, they are not the names that spring to mind as the ones engaged in the riskiest banking activities-feel that a 4% leverage ratio would do. If you examine their case and see the same evidence that I have seen, you can draw your own conclusions.

Q4325 Chair: They have been lobbying the Treasury, have they?

Mr Osborne: They have made representations to the Treasury as part of our public consultation.

Q4326 Chair: They seem to have been quite persuasive. We have listened to a lot of evidence on this and we are of one mind as a Commission. I do not think that any of us has heard anything we have not already heard. One of your points was the Nationwide point, the building society point. On that you said: "We should see how it plays out." That is what we recommend in our report, in paragraph 295. We say that it may "pose particular problems for…building societies. In view of their special characteristics, the regulator should carefully consider the case for longer transition arrangements". You would agree, though, that it would be imprudent to allow what might be best for building societies to weigh so heavily with you that it prevented you from doing the right thing for the leverage ratio for banks.

Mr Osborne: It is not just building societies. It is difficult in public session to talk to you about individual banks but, again, if you look at some of the funding models of some of our large banks, the low-risk deposit-funded banking activity might be more impacted by a high leverage ratio than higher-risk wholesale-funded banking activity.

Q4327 Lord Lawson of Blaby: May I just continue a little bit on this leverage ratio? It is all very well to look at Europe, but there are only two world-class banking centres: this country and the United States, particularly New York. You are aware, aren’t you, that the Americans are moving towards a 5% leverage ratio? Do you think that that is going to be very damaging to them?

Mr Osborne: I do not have in front of me the evidence of the impact on their industry.

Q4328 Lord Lawson of Blaby: But don’t you think that they have thought hard about it? Have you had discussions with your American opposite number on this point? They are not thinking of going to 4%, they are planning to go to 5%.

Mr Osborne: No, I have not had this specific discussion with either my new opposite number or my previous opposite number on that point. Often our discussion with the United States is around making sure that the Basel III agreement is properly implemented.

Q4329 Lord Lawson of Blaby: May I suggest that it might be sensible to reflect further on this in the light of what the Americans are doing and of the reasons that led them to reach this conclusion?

On another aspect, you absolutely correctly pointed out right at the beginning, in your initial answer to the Chairman’s first question, that the problem that led to this Commission being set up, the LIBOR scandal, was important because it was a symptom of a much wider and deeper cultural problem running through the banking system-maybe not exclusively in this country and maybe not in the whole of the banking system, but it was, none the less, a serious cultural problem. We have had a lot of evidence suggesting that one big part of this cultural problem was that the banks had lost their core value of serving the customer and they were increasingly serving themselves. They have given evidence to us that in their attempt to get back to a better culture, they will put the customer first. That immediately raises the problem of proprietary trading where, by definition, there is no customer. Therefore the culture is a totally different one-one that is diametrically opposed. In evidence, HSBC, the Royal Bank of Scotland and Barclays said that provided a sensible way could be found of doing it, they would support the idea of a ban on regulated banks to engage in proprietary trading. Where do you stand on that?

Mr Osborne: We discussed this when I was last before the Commission. I feel that we have come up with a solution that reflects the structure of our industry-with the ring-fencing proposals.

Q4330 Lord Lawson of Blaby: With respect, that is not answering the question. You have introduced structural reform, which we have sought to strengthen and you have accepted in large measure what we are doing. That is fine. That is primarily the issue of banking stability. What I am talking about now is banking culture, and this is why a number of our witnesses on these explicit grounds have felt that proprietary trading does not sit well with what banks are about.

Mr Osborne: I think they do interact with the Vickers reforms, not least because John Vickers came before you and said that he feared that Volcker on top of ring fencing might add complexities, so it is possible that it will have a detrimental effect on ring fencing. There is an interaction between the two proposals from the man who put forward one of those proposals. There is also this question, which again you see in the United States, of trying to distinguish between proprietary trading and other forms of trading in the bank. I am not sure that cultural problems, which we both agree about, are restricted to proprietary trading, or are particularly inflamed by proprietary trading. The cultural clash has often been between retail and investment banking, which is why we are ring-fencing retail banking.

Q4331 Lord Lawson of Blaby: I think there is a profound cultural difference, and most of our witnesses have accepted that. I hope that you will reflect further on it. As for Sir John Vickers, he refined his views in a subsequent appearance before us when he said, "I am not against the principle of Volcker; it is the difficulty of implementation." Clearly, one has to find a satisfactory way of implementing it, but do you share that view that if a satisfactory way of implementing it could be found, it would make sense?

Mr Osborne: First, I do not think it is necessary. We have good reforms now to the structure of our banking industry, and I do not think that we need to supplement them; we need to implement them. I would say that that should be the priority. Engaging in a whole new set of reforms, which would take a long time to legislate for and to implement, not least because there are implementation issues as the Americans are finding out, would distract attention from the primary task in hand, which is to get the reforms that are agreed through and implemented.

Q4332 Lord Lawson of Blaby: I do not understand why there is a conflict at all between them, but anyhow I have heard what you have to say.

Moving on, may I just ask you about the structure of a particular bank, the Royal Bank of Scotland, which is well over 80% owned by the Government or the taxpayer-whichever you like to say? Do you not think it is about time you considered using the power and responsibility that you have to do the classic good bank-bad bank split, which would achieve two things? It would enable you-it is the declared object of the Government-to reprivatise a large chunk of the group, the good bank, much sooner than looks likely to be the case if you do not do that. It would also be extremely helpful for lending.

In answer to the Chairman’s first question, you quite rightly said that, because the banks had so many impaired, bad debts on their books, they are reluctant to lend to SMEs as readily as they might otherwise do. It follows logically that if you have a major bank that does not have all these impaired debts on its balance sheet, it might be readier to lend to SMEs on a sensible basis, which would be good news for the economy as a whole, don’t you think?

Mr Osborne: Certainly when Lord Lawson proposes we nationalise something, we should all sit up and pay attention and listen to his arguments. The model that you advocate is perfectly reasonable. You have been the leading proponent, but others have agreed with you. First, we’d have to nationalise the Royal Bank of Scotland. I’d have to go to the House of Commons-we have Members of the House of Commons here-and justify spending several billion pounds, perhaps up to £8 billion, £9 billion or £10 billion, on nationalising the Royal Bank of Scotland. I have to buy out the minority shareholders at a presumably independently agreed market price.

So the first thing I have to explain, and what my colleagues in Parliament will have to explain to their constituents, is that I have just spent a lot of money nationalising RBS. I then have to take RBS and separate it into a good and a bad bank. That is a complex process of valuing individual assets and identifying the bad assets that should go in the bad bank and the good assets that should go in the good bank. When this was tried in the UK through the previous Government’s Asset Protection Agency, which provided an insurance for the Royal Bank of Scotland, it took about a year and a half to conduct the exercise. Other countries that have created bad banks have taken a similar length of time, so I think it is unrealistic to think that that can be done a huge amount more quickly. Then you would have, I agree, your healthy-hopefully-new bank, which you would then want to privatise.

However, I think you have to weigh up the merits of that approach, including the up-front costs, the complexity of separating the bank, and the fact that you would be left with the bad bank on your books for ever, till it ran off, and then you would have your new bank and you would privatise it. You would at least have to weigh that against the current strategy, which is to take the Royal Bank of Scotland-this is a strategy that the management and the board are now committed to-and greatly reduce its assets, and reduce its ambition from being a global universal bank with a very large proportion of its business in investment banking, and get it much more focused as a UK corporate, SME and personal bank, with an investment bank to support that activity, rather than to be a rival to that activity, and see the Royal Bank of Scotland do what it has already done, to be fair to it, which is greatly reduce its bad assets and run off its non-core.

Your proposal does not exist in a vacuum. It has to be considered alongside the alternative, which is to get RBS much more like a good bank through the strategy that it is pursuing, and that I expect it to pursue further this week. The obstacles to your approach are considerable.

Q4333 Lord Lawson of Blaby: But it may be the right approach; it may not. What you are doing is just following the approach of the previous Government. However, we have now had a lot more experience of how things have turned out, and you must surely be prepared to take a fresh look at this.

Mr Osborne: I would say we are not following the approach of the previous Government in all respects. We have kept the UKFI model-that is, this is managed at arm’s length-and we have not nationalised RBS. But as the major shareholder, through UKFI acting independently on our behalf, we have insisted that, actually, they do change their business model and they do shrink their investment bank much more than they had previously wanted to do and proposed doing, and we make sure that they become a UK-focused corporate and retail bank. That was not the plan I inherited in 2010. To be fair, the management, the board and, indeed, many of the other minority shareholders agree with that plan, because the nature of banking has changed dramatically in the last three or four years, the nature of the market has changed and the regulatory environment internationally and domestically has changed. There are lots of reasons for this, but the Royal Bank of Scotland and their management have agreed with us that the model and the plan they were pursuing in 2010 is no longer appropriate.

Q4334 Lord Lawson of Blaby: One last question on this. You rightly alluded earlier to the fact you had introduced the funding for lending scheme, which you said was not an orthodox kind of initiative. May I suggest to you that this proposal for the Royal Bank of Scotland would meet the same need and buttress it? The funding for lending scheme, although useful, is really not, in itself, enough. There is more that needs to be done, and this proposal would be a sensible, practical way of doing it.

Mr Osborne: I hear what you say, and I think we both agree on the overall objective, which is to reduce the impairment in our banking system in order to allow credit to flow and the monetary transmission to work. I pointed out to the Commission the very considerable obstacles that exist to nationalising and splitting the Royal Bank of Scotland. One has to ask whether the benefits at the end of that process, which would, as I say, be a two or three-year process, would greatly outweigh those of the current strategy that the royal bank is pursing, and which they will give more details of this week.

Q4335 John Thurso: Chancellor, can I pursue some of the detail of those questions? First, in evidence to the Treasury Select Committee, Michael Cohrs, commenting on the amount of capital that would need to go into RBS and Lloyds, said it was "a big number". What estimate have you made of the amount of capital that is going to have to go into RBS?

Mr Osborne: The estimate is done, and this analysis is done, by our regulator and by the Financial Policy Committee. They have made a judgment about some of the capital requirements in our banks, but the banks involved are very clear that they can address any concerns that exist, and have been doing so over recent weeks.

Q4336 John Thurso: On the premise that you cannot spend the same pound twice, if banks are saving their money to meet the potential new regulatory capital requirement the FPC is indicating may well be introduced, that money will not be available for them to lend to businesses or individuals.

Mr Osborne: They can give themselves-they have been doing this-more capital by restructuring their businesses, getting out of capital-intensive businesses and, if necessary, disposing of some of the assets they have. John has been heavily engaged in this, so I might ask him to answer that.

John Kingman: It is worth stressing that the Financial Policy Committee has been crystal clear that it is not acceptable to meet the needs they believe exist through deleveraging in the UK, and that has been a very important part of the FPC’s philosophy. The FPC has given a remit to the PRA to go off and negotiate with the banks on how to ensure that they are robust against the issues that the FPC has identified. As the Chancellor says, that can be dealt with in a whole variety of ways, including by changing the business models, and I think you will see material announcements from the banks about how they are going to do that.

Q4337 John Thurso: If one looks at an analysis of their balance sheets between core and non-core, surely the deleveraging is getting rid of the non-core, not reducing the core.

Mr Osborne: Well, that is the deleveraging they have been doing, yes.

Q4338 John Thurso: So there is nothing new in that-if they have to meet a new capital requirement, that is in excess of what they have been seeking to do as part of their strategy?

Mr Osborne: No. You can also improve your capital position by getting rid of capital-hungry businesses-given the overall interest of the bank, it is actually better to be out of those capital-hungry businesses, even if you are forgoing some of the profit they generate.

Q4339 John Thurso: Let me turn to specifics, because we could argue a great deal in theory. RBS’s net lending in its core business has been going down steadily since 2010. In the nine months reported to 2012, it is now down to £108.3-billion, I assume-which means that it is basically lending less, year on year, into the SME market. It has, it has been reported, something like 40% of the SME market. If an institution that has 40% of the SME market is reducing its lending, is it not a simple question of extrapolating those facts to arrive at the fact that less credit is going into SMEs than would do if they were in a position to increase lending?

Mr Osborne: I would say two things. First, there has been a big reduction in the funded assets on the balance sheet of RBS. It has gone from about £1.5 trillion to about £900 billion. That is a big reduction.

Q4340 John Thurso: That is not their SME assets.

Mr Osborne: With their SME business, it is again important to strip out commercial property, which was a particular victim of the financial crisis. When we have had targets for bank lending, RBS has actually done better than some in increasing its lending to small businesses. The Funding for Lending Scheme provides a direct financial incentive for them to increase their lending to the UK economy.

If you are telling me that the weakness of Royal Bank of Scotland has been one of the major problems for the UK economy emerging from the financial crisis, I am happy to accept that, but in the past four or five years, they have gone from great weakness and on the verge of collapse to a stronger position-a healthier capital position-and they are making further structural changes to make sure that they are focused as an SME, corporate and retail bank in the UK.

Q4341 John Thurso: I am sure you, Chancellor, and I completely agree on the problems of RBS. What I am exploring is where the problem is and what the solution might be.

In his evidence to the Treasury Committee-valedictory remarks following a speech that he had made just before he left the MPC-Adam Posen highlighted, as one of the major differences between the US economy and the British economy, and their recoveries, the lack of availability of credit in the SME sector. In particular, he highlighted the problems with the banks that we own and their inability, it would seem, to lend. I know that the Government are doing a great deal to combat that, but can we not accept that that is a problem that is worth looking at?

Mr Osborne: I think there are some invidious comparisons with the US banking system, and they are these. First, they have a much more competitive banking system and many more new entrants. I suspect that you might want to talk about that later. Certainly, I hope you address it in your report. They have many more banks, and our banking industry is heavily concentrated, partly as a result of what happened, because HBOS was swallowed up by Lloyds, and many of the smaller building societies were swallowed up by Santander and others. We have a much more concentrated banking system.

Second, this is not the purpose of this Committee, but frankly we paid a very high price, literally, for the bail-out in 2008. We paid a very high share price for Royal Bank of Scotland in the autumn of 2008, at 50p a share on average. The Americans struck a much tougher deal with their banking sector, and bought in at a much, much lower price, and they have been able to exit with a profit more easily as a result. Thirdly, our banking industry is a larger proportion of our GDP, so weakness in the banking industry spills over even more than in the US.

I think we can address those points. I cannot go back and offer a different price for the shares than my predecessor did, but I can do everything I can to get more competition into the banking sector, and no doubt we can talk about that.

Q4342 John Thurso: That brings me neatly to my last question, which follows on from the remarks you made in your Bournemouth speech. You said that the "banking sector is now dominated by a few big banks. It verges on an oligopoly. 75% of all personal current accounts are in the hands of just four companies." Would not the discussion we have just been having lead one to look at the possibility of widening the number of players available by looking at restructuring the ones we own? Should the societal and competition benefits that are there at least be given equal weight with the pure number-crunching benefit, which you rightly pointed out may not be advantageous for the country? In other words, what it could do for competition and society might have a counterbalance in value that would offset that.

Mr Osborne: I am prepared to entertain that argument in theory, but in practice, as I was explaining to Lord Lawson, it is quite a long haul to get to the point where your nationalised, broken up and re-privatised RBS is out there expanding its business. There are some other, more immediate things we can do. First of all, I have sold Northern Rock-the good part of Northern Rock-to Virgin Money in order to get some competitors out there on the high street. We are engaged in trying to sell the RBS and Lloyds branches that the EU required as part of the 2008 settlement. The FSA is very shortly, and at our request, going to produce a paper on what it can do to support new entrants into banking-things like the capital requirements that are imposed on new banks-and help to expand the banks that have started to grow, such as Aldermore and Metro, and we want to see more of that.

As I said in that speech in Bournemouth you referred to, we are now looking at regulating the payments system, which has been owned by this oligopoly. The Payments Council, which sits over it, has been run-dominated-by those banks. We want to take the power to regulate that industry and break up that oligopoly, so that, actually, if you are a new entrant, you do not have to beg one of the bigger banks to be able to use their financial pipelines and wiring; you can offer your own service and have an independent regulator help you to provide it. No doubt we will come on to talk about switching. There are many other things that we can do to try, but if you want to see more entrants onto the high street and you want to see those entrants that exist growing, I am your strongest supporter.

Q4343 John Thurso: Given that it is nearly a decade since Cruickshank, has the time not come for an immediate referral to the competition authorities rather than waiting until 2015?

Mr Osborne: First of all, actually the OFT looked at this very recently, and it has not recommended an immediate referral to the Competition Commission. I think what Cruickshank did recommend was the regulation of the payments system. The last Government, for their own reasons, chose not to take that up. We are taking up, albeit 10 years later, Cruickshank’s recommendation on that. I think that will help a lot with competition. It is a difficult, delicate balance. If there was a referral to the Competition Commission of the banking industry, that is what they would then spend the next two or three years focused on, rather than trying to grow their businesses and expand their lending. You would have to weigh up the benefits of making that referral versus the immediate costs to our recovery. It is not just my view, but the view of the Office of Fair Trading and the view of the John Vickers commission, that that was not therefore a sensible thing to do.

Chair: We are running somewhat behind schedule, but we will do our best to get all colleagues in.

Q4344 Baroness Kramer: Thank you. Chancellor, I would like to stay with the issue of competition for a moment. I do not think you would find anyone here who would disagree with the kind of changes that you just described-making it easier for new banks to enter and dealing with the payments systems, switching accounts and so on-but the evidence that we have heard suggests that, for the process of bringing in new entrants and developing the alternatives, we are talking about more than a decade before we really have an impact on the competitive situation, in the way that you appear to think is desirable. We will be out of this economic cycle and well into the next one before the real impact of that strategy will come through and be effective.

Going back to the discussion on RBS and the conundrum that you face in deciding what on earth to do with it and the Government’s ownership in it, let me press you on why you do not use RBS as a mechanism to inject competition far more rapidly. I lived in the United States at the time of the breakup of AT&T into the Baby Bells, and that took the minority shareholders along with it. Why not adopt a strategy for a regional break-up of RBS, for example, returning stocks of that mixed bag to the shareholder, to give you both competition and an answer to your albatross problem?

Mr Osborne: I do not want to repeat myself, but I have explained why the route of nationalisation and break-up is-

Q4345 Baroness Kramer: Can I stop you there? You always say nationalisation and break-up, but that was not necessarily the AT&T process, and I cannot see why it is in this one.

Mr Osborne: Because in order to get control of the firm-

Q4346 Baroness Kramer: In which you have a controlling shareholding.

Mr Osborne: We are a majority shareholder, but our law quite rightly entrenches the property rights of minority shareholders.

Q4347 Baroness Kramer: But you are not taking away from minority shareholders. It is merely that they get a make-up that reflects a portfolio that reflects the whole, rather than one individual share that reflects the whole. That is exactly the strategy that has been used to facilitate things in the past.

Mr Osborne: But I am not sure that they would take the view that the broken up RBS was worth more to them than the intact RBS. You are making an argument that there is an economy-wide benefit to that-not to the shareholders-and that the Government would forgo any profit or take a loss on its shareholding in order to achieve something broader for the economy. I am just pointing out that there are some quite serious practical obstacles.

We have here members of all the political parties, as well as Cross Benchers from the Lords. We can imagine that a Chancellor of the Exchequer getting up and saying, "I am about to spend £7 billion or £8 billion of public money nationalising RBS," would not be an entirely uncontroversial announcement, and it would not necessarily command broad support. You would also, as I say, have to engage in the costly and time-intensive process of valuing good and bad assets.

There is an alternative route, which is to get RBS very much focused on being a UK SME, corporate and retail bank, with an investment bank that supports that activity rather than rivals it. I think we have made considerable progress with the management and the board in achieving that, and there will be further progress this week.

Q4348 Baroness Kramer: So you would do it even though it left a barely competitive and still heavily overconcentrated environment?

Mr Osborne: To entertain your concept that the break-up of RBS might provide a new NatWest or a new RBS in Scotland, I think we need many more banks than that. We have a load of RBS branches up for sale; let’s get them sold. We have a bunch of Lloyds branches up for sale, which the Co-op is interested in-obviously that is a commercial deal, but I am very keen to see that happen. Let’s help those new banks that are out there expand. I am a bit more optimistic than you are. You said at the beginning of your remarks that this will all take 10 years. If you can get the competition going-let us hope and expect that the economy is improving-I think you could see quite rapid growth of these successful new challenger banks. That is certainly what I am determined to try to achieve.

Q4349 Baroness Kramer: It sounds as though you accept that concentration is a problem, which it is. We took evidence from Michael Cohrs, who suggested that the UK should consider a limit on bank size based on the proportion of retail deposits, and he cited the US cap of 10%. That is not necessarily a magic number, but would you consider looking at that approach to try to get a less concentrated and inherently more competitive environment?

Mr Osborne: I think that would have a pretty dramatic impact if you introduced it today. It would cause quite a lot of uncertainty in the banking sector, to put it mildly. We asked John Vickers specifically to look at the size of Lloyds post the HBOS takeover, and the fact that it had a third of the current accounts. They recommended a divestment, which we are now in the process of seeing through. We have competition authorities and regulators in this country, and we are giving the FCA-partly at the suggestion of the Treasury Committee, I think-an explicit remit on competition, so the tools are there to make this happen. I wish it could happen overnight, but that is not the nature of this very large industry. However, it is becoming more competitive.

Q4350 Baroness Kramer: Let me ask you one last, quite narrow, question on competition. You mentioned the importance of dealing with capital requirements as a barrier to entry, but our understanding from discussions with the regulator is that there will continue to be this divided system in which large banks with a long history will be able to take advantage of risk-weighted asset calculations and internal models to determine the level of their capital, whereas new and small banks will be stuck with the standard model. You know the difference in the ratios: for a modest mortgage, say, you hold 40% capital under the standard model, but between 8% and 18% under the risk-weighted asset model-a huge differential in capital cost. How are you intending to tackle that constraint, which would surely limit the capacity of new entrants?

Mr Osborne: I agree that that is one of the frustrating barriers to entry. Our regulator in this country is independent, but at my request it is shortly going to be publishing a paper on what it can do to reduce those barriers to entry and to expansion. It is looking very specifically at things such as the role of some of these models for existing banks versus the requirements on new banks. I do not know whether John wants to say anything.

John Kingman: As you say, we expect the FSA to produce proposals on this very shortly. They have been talking a huge amount to the challenger banks, quite rightly, both about the exact issues you raised on capital, where they have a proposal that they intend to bring forward that reflects a lot of discussion with the challengers, and about the very important issue of speeding up the process of approval for a new bank, which has been a big issue as well.

Q4351 Baroness Kramer: I accept the latter, but not that they are coming up with solutions on the former, which is why I am concerned.

John Kingman: I hope you will judge that when they publish.

Mr Osborne: I cannot remember-are they coming in after me?

Baroness Kramer: Yes.

Mr Osborne: Well, then you can put lots of pressure on them and help me.

Baroness Kramer: Yes.

Q4352 Chair: Just to clear up a couple of things you said there, Chancellor: you said that you had given the PRA an explicit remit on competition, but it is only a duty to have regard to competition.

Mr Osborne: I was referring to the FCA.

Q4353 Chair: Ah, you were referring to the FCA. You have also done the same for the PRA. You have done something better than that for the FCA, but for the PRA you have just given them this duty to have regard to competition. As we have discovered and had evidence on, "have regard" is really "have no regard"-it is an "or ignore" duty. We know that from all our experience with the "have regard" duties under FSMA. Would you consider again our proposal that it should be a secondary objective of the PRA?

Mr Osborne: I am always happy to consider that idea. I do not think that I am telling tales when I say that it is the Bank of England that has been particularly concerned about that as a primary requirement on the PRA, because their view, to be fair to them, is that nothing should get in the way of their prudential obligations and the safety and security of the banking system. The competition issues are rightly ones of conduct, and they should be rightly the focus of the FCA, but not at the top of the list of the PRA’s requirements.

Q4354 Chair: Well, according to the smoke signals that I am getting from the Bank of England, they are not quite as opposed to the idea as they used to be, so perhaps you would like to go back and see what signals you get.

Mr Osborne: You also have the Governor coming after me. You can beat up on him as well.

Q4355 Chair: We will have a word with the Governor.

A moment ago, you said the Government-I take it that is who you meant when you said "we"-have made considerable progress with the management of RBS in achieving an investment arm of RBS which supports rather than rivals the retail arm. Have I got that right?

Mr Osborne: Well, the Government acting through UKFI, in the proper way, and with the support of the management and the board.

Q4356 Chair: I am just wondering what is left of this arm’s length UKFI.

Mr Osborne: UKFI has got some very independent-minded and effective people.

Chair: Okay; well, I think we can all draw our own conclusions from that answer.

Q4357 Mr Love: Chancellor, can I bring you back to comments you made a few moments ago about the payments system? Did I hear you correctly suggesting that you are now attracted towards the PayCom model first suggested by Mr Cruickshank some 10 years ago? Could you say a little more about the change in direction from the previous consultation to where we are now?

Mr Osborne: We are going much further than we had previously indicated, and I spelled this out in the speech that the Commission has referred to. Our feeling is that self-regulation of the payments system has not worked: it has acted as a barrier to new entrants and to challengers who want to do interesting new things with the services they offer their customers, such as 24-hour banking, and it is not really acceptable that a new arrival-a new, small and dynamic arrival-has to go to one of the big existing banks to get their permission, in effect, to use their payment system. So we are looking at independent regulation of the payment system, moving away from the self-regulation model, and I hope at around the time of the Budget to produce the consultation document on how we intend to do that.

Q4358 Mr Love: Let me just press you a little bit: will that be along the lines of the utility regulatory model-that they will have power to set prices and the conditions under which everyone operates within the marketplace? Clearly it is a consultation and there will be options, but the Government made it very clear-or the Treasury made it very clear-in the first stage that it was impressed by the payments strategy board hybrid. Are you now going to set out your stall in favour of a utility model?

Mr Osborne: The short answer is yes, something much more akin to a utility model. We are going beyond what we indicated last year, partly because we felt that we need to do more to get those new entrants. John, I don’t know if you want to say something, because you have been heavily involved in this.

John Kingman: The key thing is these networks have some oligopoly characteristics and we need a regulator which has the power to deal with those, rather as has been done in some utilities. That would certainly look at the potential to abuse market power on pricing; it would also look at fair access for new entrants and all of those issues, which, as you say, is fairly well covered ground in the utility sphere. I don’t think there is anything that is exactly comparable to this, but it is the same broad approach.

Q4359 Mr Love: One of the other areas that the Commission has been looking at is a common utility platform-this has been suggested by, among others, Andy Haldane-where you would have an IT structure that banks would plug in to, and individuals would be able to change; there would be much greater flexibility for the ordinary customer. Is this something that you have looked at, at all, or is that very much out there and too far in the future to be considered?

Mr Osborne: I think both those things are true in the sense that we have looked at it and we are happy to go on looking at it, but it is quite far in the future, because I think the cost and the time required to create a single IT system for the whole banking industry, and the concern that it would not become itself deeply old-fashioned and oligopolistic and not allow for new innovation in technology, are at least serious questions.

We have got switching coming in from September this year: if you want to switch your bank, you should be switched within seven days, all the direct debits, and everything, should be switched with it, and if there is a financial loss because of some mistake along the line, you are protected from it in the switching. That is going to be quite a major change, and the banks have spent a lot of money getting to this point. That was one of the recommendations of John Vickers’ report. It is at least open to debate whether we now need to go beyond that and create some vast new IT system, as is whether there is such a premium on unique bank accounts.

People do have the same bank account numbers as other people in our society, because there are different banks and different sort codes. You would also have to renumber everyone’s bank accounts as part of this process. The bank account is different in that respect from the mobile phone. The bank account number is not quite as important to you as your mobile phone number in the sense that changing your mobile phone number creates a lot of hassle as you have to tell everyone your new number, whereas changing your bank account number, assuming that all the direct debits and everything connected with it change automatically, is not quite so difficult. There is not the same uniqueness associated with your bank account number. Those are just some of the questions I have about direct account portability.

We are doing two things. First, from September, we will be able to see whether the switching service works. The banks are under no illusions that if switching is not working and people are not switching their bank accounts and there is no competition in the industry, we will look to go further. Second, we are giving this new payments regulator-Parliament has to decide which regulatory body is to be given that power of regulation-the power to look into this area as well, so we will have an independent view on whether we need to go further in the way that you have suggested.

Q4360 Mr Love: I want to come back to the seven-day switching service. In terms of the common utility platform, have you considered entering into a dialogue with the industry at least to indicate the direction of travel? I understand that this may be far in the future, but would not an early indication of thinking in this regard and some debate and discussion be useful?

Mr Osborne: We do talk to the industry. As I say, they are under no illusions about the importance of the switching changes in September. They are at least becoming aware of our intentions with the Payments Council, and that will be made clearer to them in the next few weeks.

Q4361 Mr Love: A couple of days after your speech in Bournemouth, which we have all read with great interest, Vince Cable, talking about the seven-day service, described it as an important step towards full portability of accounts. He seemed pretty convinced that the seven-day service is a port of call on the eventual move towards full account portability. Do you share his view?

Mr Osborne: Dr Cable and I see alike on almost everything, apart from a mansion tax.

Switching is a brand new service. Is switching going to provide that account portability, in effect, or do we really need to go beyond that? I am not closing any doors-hopefully, I am opening some doors with the regulation of the Payments Council-but having invested several billion pounds, I think, and certainly hundreds of millions, in getting the switching service operating from September, we do not have to rush immediately to the next thing. Let us see whether this works and whether our new payments regulator thinks there is a serious problem.

Q4362 Mr Love: The evidence from the Netherlands, which introduced a similar system some time ago, is that the system actually works, but it has not increased switching-for very complex reasons, no doubt. If that happens in this country, is a necessary requirement of this seven-day system that it increases the level of switching, or just that it works in terms of what it promises?

Mr Osborne: I do want to see more switching. This is not just a problem in banking; it is a problem in electricity, gas, water and telephone services.

Q4363 Mr Love: Almost all of them have much more switching than banking.

Mr Osborne: They do, and it would be good to get current account switching up to something approaching the levels you get in some other utilities, but even that is not far enough.

Q4364 Lord Turnbull: We were told by Philip Hampton that the LIBOR fine of some £380 million incurred by RBS is being split in two, with £300 million of it is going to the US authorities and the other £80 presumably staying here; and that the bonus pool was being reduced by £300 million. We could not really see the logic of why the £80 million, which is being paid to the UK FSA, should not also be part of the reduction of the bonus pool. What is the logic for splitting it that way?

Mr Osborne: The logic was this: first, I felt very strongly that the public would be outraged if their bank, of which they own 80% or so, was paying money out to a US regulator and not-

Q4365 Lord Turnbull: We are very happy with that half of it. It is the £80 million I am asking about.

Mr Osborne: The £80 million for the FSA. I have changed the rules on this. Previously, fines went back to the FSA and helped the FSA reduce the levy to other players in that part of the industry, so the result of the LIBOR fines, which are very much larger than fines that have been paid to the FSA in recent years, would have been that the FSA levy for other banks was reduced. I did not think that that was appropriate. The money from the LIBOR fines is going into good causes. As it happens, on Friday I was in Birmingham at the Queen Elizabeth Hospital where our wounded soldiers come back to from Afghanistan. The LIBOR money from the Barclays fine is being used to build a new respite home for the veterans’ families-

Q4366 Lord Turnbull: Let us stick-

Mr Osborne: What I am saying is that this money is going to be recycled into our society rather than leave our society and cross the Atlantic.

Q4367 Lord Turnbull: But as a result, the shareholders of RBS are effectively £80 million down. Who are the shareholders of RBS? The taxpayers.

Mr Osborne: Except that the money is going back to the public.

Q4368 Lord Turnbull: But why should it not also come out of the bonus pool so that the shareholder value, which is our value, is maintained?

Mr Osborne: It is just a different judgment, Lord Turnbull. I thought, as the money was going back to the public, it was not as egregious as the money going to the American taxpayer.

Q4369 Lord Turnbull: I think what is egregious is that the fine for their actions is not being paid by a reduction in their bonus pool in total.

Mr Osborne: A very large proportion of it is. The rest is going not to reduce the charges banks pay for being regulated, but is instead going to good causes. By the way, it is a transformative sum for some of these charities-we are talking about tens of millions of pounds. It is going to make a real difference to some very good causes. As I say, at the moment we are focusing that on military good causes.

Q4370 Lord Turnbull: It says that the bonus pool is being reduced by £300 million. I hope that the arithmetic will set out what it otherwise would have been, so that we can see that it really is a proper reduction.

Mr Osborne: On the 28th of this month, I think, when they produce their results, they will set out where the money comes from, but it is from claw-back, a reduced current bonus pool and reduced future bonus pools.

Q4371 Lord Turnbull: I think the effect is that, after you have reduced the bonus pool by £300 million to compensate for the money going to the US, the FSA is plus £80 million and the shareholders are minus £80 million, and therefore the public sector is left even. So in effect we are not levying a fine on the bank.

Mr Osborne: Well, we don’t own 100% of RBS.

Q4372 Lord Turnbull: We have 84% of it.

Mr Osborne: We are trying to get the balance right between running these banks as independently managed banks so that they can, hopefully, at some point return to the private sector, and at the same recognising public anger and concern and political-in the best sense of the word-concern about things that went wrong in these banks that we bailed out. We can have this discussion, but personally I think that we have got the balance right. The fine that is going to the Americans is paid for by the bonus pool, and the fine that was going to the FSA is instead going to go to charities.

Q4373 Chair: Well you can hear some disquiet here about the £80 million from a number of us, and you can also hear some concern that not enough thought was given to the base sum from which this bonus pool is going to be taken, so that we can have assurance that it really is a reduction on what bonuses would otherwise have been.

Mr Osborne: Hopefully, reassurance on that latter point will be provided by the information that we are asking RBS to publish later this week.

Chair: We’ll see.

Q4374 The Archbishop of Canterbury: Chancellor, you will be aware that the evidence we have had has shown two particular things about culture and standards. One is that the banking system through the early parts of the last decade was operating very much in a bubble, separated from any concept of social utility. Secondly, the culture permitted vast areas to become corrupted, either through mis-selling or through the manipulation of market prices. We have a redesigned architecture of regulation and we have the banks producing large numbers of statements of purpose and values. Do you think that will be sufficient to maintain or restore trust and standards in banking?

Mr Osborne: No, I don’t. That is the short answer. That is why Parliament asked for this Commission to be created. The area that is least developed and least covered by the legislation that I have put to Parliament is around the ethics and culture of the banking sector and how that can be improved, and how, either through developing the kind of professional standards and regulators that you see in the medical profession or the legal profession or through some expansion of our existing approved persons regime, for example, we can achieve that. I am happy to agree with what is implied by your question that much more needs to be done.

Q4375 The Archbishop of Canterbury: One bit of evidence that came out most memorably from the former head of the Union Bank of Switzerland, but confirmed by numerous others, is that you can have big simple banks or small complex ones, and you can usually manage them if you are competent. Big complex banks are not only too big to fail, but they are too big to manage, yet this afternoon we have heard you continue to defend the idea of a small group of absolutely colossal banks, including RBS, which even in its reduced size is still enormous and highly complex. Is that lack of will to break them up and reduce them to a size that eliminated risk to the economy not simply a recipe for a repetition of the disasters we have seen in the past few years?

Mr Osborne: No, I don’t think so. I completely accept that running a large complex bank is a difficult task and can fail. That is why we are ring-fencing the retail banks, so that we can protect the thing that is essential for the functioning of the economy. I do not think it would be possible to create in Britain a world where we just had a lot of very small banks. We live in a heavily interconnected global economy, and some of the big players in our country are not British banks. Unless we were to close our doors to all of them and close our financial centre, which I don’t think is realistic, we have to make the banking system, with its economies of scale, work for the UK.

Q4376 The Archbishop of Canterbury: The evidence Andy Haldane showed us is that there are no economies of scale at this size-in fact, quite the reverse. Foreign banks are not our problem; they are the problem of the regulator where they are located. What about the British banks? The evidence was not that they are difficult to manage when they are big and complex, but that they are impossible to manage when they are big and complex.

Mr Osborne: The reason that this is perhaps the most regulated industry that we have is precisely because the risks of getting it wrong are considerable and the impact when it goes wrong is also considerable. That can be true of small banks as well as large banks. Victorian times-indeed, Victorian literature-were littered with the failure of small local banks that caused enormous hardship for individuals and contagion across the wider system. Northern Rock was not an enormous bank when it failed. I don’t think you can say it is just a problem of large universal banks. In a global economy, it is useful to have institutions that have some global reach. It would be a shame if very large British corporates such as GlaxoSmithKline, for example, or BP, felt that there was no British bank that could handle their bank account. They do feel that there are British banks that can handle their bank account, and it would be a shame if they felt that they had to go to an American bank to do that. Equally, when a small or medium-sized business in Canterbury wants to export to somewhere in Shanghai, it is sometimes useful for them to operate with a bank that has a branch in Shanghai that can handle that transaction, which in the scale of the world is a relatively small one, but in terms of the complexity of trading between sterling and renminbi is quite a complicated financial product.

It is all in context. The banks got too complex; that is why we are trying to simplify them and is why we are ring-fencing investment banking from retail banking. We are trying to simplify the banks, not just to help the regulator or, indeed, a Chancellor when they face the invidious decision of what to do when a bank fails, but also to help the management of the bank; indeed, some of the strongest arguments for the ring-fencing reforms have been about just making it easier for managers to manage a bank.

Q4377 The Archbishop of Canterbury: What is your approach to controlling the significantly increased risk of these global banks? That is the evidence that we have heard-that they are significantly more risky to the British economy. When you see a bank growing rapidly, acquiring vast numbers of new businesses, developing its complexity both inside and outside the ring fence, what would you see as the right approach to a bank like that?

Mr Osborne: There are two things. One is that I hope that now we would have regulators-particularly in the Bank of England and the PRA-that would ask questions of judgment rather than just questions of form-filling. I would like the deputy governor of the Bank of England and the head of the PRA to ask basic questions about whether, when you take over ABN AMRO, for example, that is really a sensible exposure for a large UK bank to take, even if it ticks every regulatory box. That is part of the answer. Part of the answer is also around the simplicity of structure that the ring-fencing will provide. The third point, which is not particularly at the forefront of politics, but we were talking about earlier, is the recovery and resolution plans. You would expect a complex, large bank to have in place a very detailed resolution plan. By the way, we need the resolution plans not just for British banks, but for foreign banks, if they fail; Lehman Brothers was, after all, an American bank, but had a very considerable impact on the City of London.

Q4378 Lord McFall of Alcluith: Following the Archbishop’s comments, how far away are we from solving the questions of being too big to fail, too big to manage and, maybe, too big to prosecute?

Mr Osborne: I think we have made quite a lot of progress. I feel that the next time a Chancellor of the Exchequer faces the decision that Alistair Darling had to face on a weekend in 2008, they would feel that they had many more options than Alistair felt he had. First of all, you would be able to look at a failing universal bank and be able to protect the payments, the cash machines and the things that are essential for the functioning of the economy. Second, there would be an off-the-shelf resolution plan that would at least give you a very good place to start with trying to deal with the bank. Third-this is a point now forgotten, and was addressed by legislation both under the previous Government and under the current Government-he simply did not have some basic legal powers that he needed. The Bank of England did not have some basic legal powers. So I think we have made quite a lot of progress. Ultimately, of course, anyone doing my job in the future would have to face that very difficult decision, which is, if you let the bank fail, are you going to have a repeat of the Lehman Brothers situation, or actually are you now confident enough that the thing will wind up in a way that is less destructive?

Q4379 Lord McFall of Alcluith: I think you are still a bit away from that yet.

Mr Osborne: I want at least to keep people guessing. That is quite an important part of moral hazard.

Q4380 Lord McFall of Alcluith: You mentioned that ethics and culture is the least improved part of the remit, and that is why you gave us this remit. We have had looked at mis-selling such as PPI, which has gone on for 18 years; it has taken a generation, almost, to get it sorted out. First, how sympathetic are you to the idea of companies having a duty of care to customers? They are coming before us and telling us that the customer is going to be first, as Lord Lawson said. Secondly, in terms of institutions, how sympathetic are you towards the concept of a duty to society? I am mindful of Hector Sants just before he retired saying that companies need an obligation to wider society. Indeed, he recommended a change to the Companies Act regarding directors, where the current requirement to promote the success of the company, which is interpreted as shareholder value, is inadequate and we need to do more. On those two points, how sympathetic are you to that?

Mr Osborne: I am very open-minded about those. I have said already that the area where our thinking is least developed and where the Commission can provide huge input is on this whole question of culture and ethics. This is not directly addressed by the legislation we have introduced, and it is one of the strong reasons why I wanted to create this Commission. Issues of duties to customers and more broadly are something I am very happy to look at.

Q4381 Lord McFall of Alcluith: Good. On the issue of transparency, it is said that sunshine is the best disinfectant. Given the issues of remuneration, would you be sympathetic to the view that it is not just the quantum of pay that matters but the performance criteria on which variable pay is based, so that shareholders and stakeholders can understand how companies have developed their remuneration policies? Given that it is all about transparency, is there not a case for companies just to disclose the number of employees who are earning, say, over £1 million, so that people know exactly what the situation is in financial services compared with other industries in the country?

Mr Osborne: On remuneration, first of all the level of bonuses is dramatically lower than it was. In 2006, there was £11.5 billion of bonuses in our banking system, and in 2013, it is estimated to be £1.5 billion. It is a pretty dramatic fall. We have a very much more transparent regime and there is much more clawback than there was, and we lead the world. We have to have some regard for what the rest of the world is doing, and indeed there are discussions at the moment in Europe on European rules on remuneration. Actually, we have lived up to our international obligations, which, again, both this Government and the previous Government entered into with the G20, to create this transparent regime. Not everyone else, frankly, has done so. I think we have got to get the balance right between what we have at the moment, which is the most transparent regime-

Q4382 Lord McFall of Alcluith: You have asked us to be radical, so I am just pushing you on this point.

Mr Osborne: I think David Walker originally came up with this idea, and he said that he would not want to impose it unilaterally in the UK; he would want to see it implemented at a European or international level.

Q4383 Lord McFall of Alcluith: On inequality, which is a big issue politically at the moment, my colleague the Archbishop said in the House of Lords recently that "since the 1980s the multiple between the average earnings in FTSE 100 companies and the earnings of top executives has risen from about 29 times to at least 140 times", and he pointed out the dangers to social cohesion. Is there not some initiative that can be taken in the banking sector at the moment regarding living wages? Barclays and HSBC have indicated they are open to the concept of a living wage but RBS, which is 86% owned by the taxpayer, has turned its face against that. Would that not be a good sign to the rest of society that we are all in it together?

Mr Osborne: I am happy to go away and look at the specific case with RBS, although, as I say, I do not run RBS. I do think that banks have to have a regard for the way they are perceived and the way they behave. I think that banking and financial services pay has got completely out of kilter with the rest of the economy. It has come down a lot from its highs, but it is still many multiples of what executives in general get. An executive in a pharmaceutical business or in a manufacturing firm would not get the kind of remuneration that you would get in the financial services industry now. I do not want to run a pay policy, because we tried that in this country and it did not work. It is the responsibility of the shareholders in the end to ask whether they are getting value for money.

Q4384 Lord McFall of Alcluith: It is not the case that it is the brightest and the best who are in the banking service industry, or that they are cleverer than the rest of us. It is all about the incentives structure, is it?

Mr Osborne: No, there are some very bright and good people in banking.

Q4385 Lord McFall of Alcluith: Are they cleverer than the rest of us?

Mr Osborne: I don’t think that they are cleverer than the rest of us. I think this is something for the industry to address. Basically, if you want my real opinion, they had an argument before the crash, which is that "We undertake very risky activity; we generate enormous rewards; and that is why we should be paid so much." Then it turned out it was very risky activity, except for many of them because when the banks failed they did not collapse; they were rescued. Far from being a great benefit to the rest of the economy, it cost us hundreds of billions of pounds. I think that their argument for why they should be paid so much looked a little bit thin in the banking crash and has remained thin ever since.

Q4386 Lord McFall of Alcluith: I remember Professor Charles Goodhart coming before one of the Committees a number of years ago and saying that any industry that excludes 50% of the population-namely, women-is not going to best serve the interests of the economy. What would make you act legislatively if you saw this industry dragging its feet?

Mr Osborne: I don’t want to run a pay policy, and I don’t want to run a quota policy, as in a gender quota policy, in the industry. It is a private industry. Like other parts of the private sector, the owners of the industry should have a much greater regard for whether they are getting value for money.

Q4387 Lord McFall of Alcluith: From a prudent and canny investment point of view, Chancellor, in preparing for this I looked up the Paddy Power website at the weekend and saw that your odds have increased to three to one. Given that you are canny-

Mr Osborne: Three to one on what outcome?

Q4388 Lord McFall of Alcluith: Three to one on you remaining as Chancellor over the next year. What advice do you have for me? How much should I put on that bet?

Mr Osborne: I am not giving you betting advice. As the financial services industry says, you need to make your own judgment.

Q4389 Mark Garnier: Chancellor, if we could turn back to the Payments Council and the concept of a utility payments system, which Mr Love was asking about a bit earlier. Obviously, you have talked about the potential of a payments regulator, and we look forward to your statement on that. When it comes to the utility payments system, obviously what the seven-day switching is addressing is competition. Would you not agree that there are wider issues that can be addressed by a new utility payments system, which VocaLink is looking at in terms of attaching the account number to the sort code and then drawing that within its system, as opposed to leaving it in the banks? Actually, the benefits could also be to improve resolvability of failing banks and to bring about greater transparency of the system, thereby giving the FPC a better opportunity to see what is going on. Finally, a point that Andy Haldane made, which is that given the antiquity of the IT systems in the existing banking system, now is about the right time to start moving on anyway.

Mr Osborne: Looking at all of this is one of the reasons for getting some independent regulation of the payments system to be able to make judgments on things like whether the IT system is non-effective or on new entrants who want to offer new products. As I have said, I am happy to go on looking at what more we can do to encourage switching. The question we have to answer is whether the considerable cost involved is really worth the goal of everyone having a unique bank account. As I understand it, but I am happy to be guided by your investigation, everyone in this room would have to be given a brand new bank account now, which is quite a disruption.

Q4390 Mark Garnier: No, it wouldn’t. The way you would do it is to attach a bank account number to the sort code and that discrete unit would be transferable. That is what VocaLink is proposing, and it actually gets around this whole system rather well. You are absolutely right to say that new entrant banks would have a problem with the IT system, but it is the existing legacy system, which is based on old punch-card systems from the ’50s, that we saw collapse last year. Mr Haldane told us that 80% of the IT spend by banks is used to hold it all together with string and chewing gum.

Mr Osborne: You have to ask yourself why that is the case, because, in lots of other areas of financial services, people have invested in the latest technology. I would say one of the main reasons is because it is an oligopoly, and there is no great incentive to improve these systems. We have certainly had challenger banks wanting to offer innovative 24-hour banking products or very quick clearance of, for example, small business transactions, and they have just been unable to do that, because the bigger bank whose system they are using will not allow it, or its IT system will not support it.

Q4391 Mark Garnier: So you think the answer is to drive it through a new regulator?

Mr Osborne: There are two things. One is the switching service that is coming on stream. Let us see how effective that is. A lot of money has been invested in that. Then, we also give to this new payments regulator exactly the kinds of powers that other regulators have had-look at communications-to break open communications networks, which were a monopoly provided by British Telecom or whoever and have proved more open to new entrants.

John Kingman: The point we need to think about here is, what are the powers and duties of the new regulator? In other utilities, the regulator has a clear role in requiring new investment, for example. I am not saying that is the right answer here-we need to think about it-but that is exactly what we are going to consult on.

Q4392 Mark Garnier: That will be the way to drive it through. Thank you, that is very clear.

Can I just follow on from the point about corporate governance, which the Archbishop mentioned a bit earlier? Going back to the evidence given to us by UBS when the senior managers came in who were in charge of the bank at the time of the LIBOR scandal, were you as surprised as we were that none of the senior managers of this bank had the first idea about what was going on in their bank until they read it in the FT?

Mr Osborne: I have read the newspaper reports of the hearing; I have not actually studied the transcript of the hearing. That is one of the reasons UBS probably got into more trouble than almost any other bank in the world. I think there were particular problems in that bank, and what is their response? Their response has been-this is a bit of an exaggeration-to get out of investment banking. They have certainly got out of their fixed-income investment banking. What is interesting is that the market reaction and the shareholder reaction was that the share price went up. Coming back to the point the Archbishop made, one group of people who have suffered in the crisis has been shareholders, who have seen the value of their shares dramatically written down in some cases. They are demanding simpler structures and more transparency about what is being earned and the capital that is being consumed in earning it. You saw a pretty vivid demonstration of that with UBS.

Q4393 Mark Garnier: The point I am trying to get to is this. A day or two later, we had Tracey McDermott from the FSA investigation department before us. The key, most remarkable point was that at no point did the FSA interview the managers responsible for the bank or even have just a general conversation with them about what was going on in their institution. The argument she made was that, as an investigator, she will follow a trail until it goes cold. The implication of that is that if you are a manager of one of these banks, there is an incentive to set up an accountability firewall so that you will definitely not know what is going on in your organisation. You can then guarantee that, through, if you like, wilful ignorance, you can never be implicated in any scandal that is going on in that organisation. That is the key point about this. Do you not think the regulator is failing very badly by not even vaguely holding to account the management of organisations?

Mr Osborne: I do not think the approved persons regime is the be-all and end-all; that is one of the things that I hope that you are going to look at. Although the FSA does conduct many more face-to-face interviews-indeed, it started doing that in 2010-I am not sure that that is entirely sufficient. Of course, people who run banks, like people who run any large organisation, need to have a management structure where they know what the hell is going on.

One of the other things that I hope that the industry has learnt is that the amounts of money that they made on LIBOR manipulation have been completely dwarfed by the reputational damage, the costs to their careers, in some cases, and the fines that they have had to pay. If you are only focused on making a fast buck, hopefully the incentives now have changed such that: your bonus is clawed back, rather than just being given to you in cash in your bank account; the fines are draconian; and the reputational damage in the current climate is enormous.

Q4394 Mark Garnier: What we are worried about, though, is that the personal reputational damage is pretty limited. I completely agree that the organisation faces severe reputational damage, but there are many people who have been running these organisations who have come out fairly scot-free, notwithstanding the Barclays managers, and have now moved on to pastures new: the people who ran UBS have now gone on to other jobs and they seem perfectly happy. The personal reputational damage does not seem to be there.

Mr Osborne: If you take the LIBOR scandal, the chief executive and chairman of Barclays resigned, and in the case of RBS, the head of investment banking has resigned. Reputations have suffered.

Q4395 Mark Garnier: That was more as a result of the Treasury Select Committee beating them up a bit, as opposed to the Banking Commission.

Mr Osborne: Well, one of the ordeals of being in banking these days is that you have to sit here and answer questions.

Q4396 Chair: Yes, but as one of the regulators said to me the other day, he does not think that the regulatory system should have to rely on Parliament to do its work as an extra tier of the disciplinary system. Do you not agree with that?

Mr Osborne: Yes I do, although Parliament, as one of the forums for public engagement in our society, has a legitimate role in all of this. If you take the action of the chairman and chief executive of Barclays, I do not think that that was brought about by Parliament; I think that there was a very clear message from the regulators that they received.

Chair: I am very conscious that you have been on the go for quite some time today already-

Mr Osborne: That is all right.

Chair: But I have a couple of colleagues who have caught my eye and I will bring them in quickly: Pat McFadden and then Nigel Lawson.

Q4397 Mr McFadden: I want to ask a process question before you leave us, Chancellor. You have talked today about how the arena of culture and standards is, in some ways, the one that has been the most underdeveloped in terms of change in the last few years. That is front and centre in our terms of reference and it will be the focus of our second report. Can we have an assurance from you that there will be the legislative opportunity to enact any legislative changes that we come up with? Obviously, the Government will make its judgment on whether it accepts our recommendations or not, but in terms of legislative time, will there be time in this banking Bill to enact necessary amendments that might come out of our second report?

Mr Osborne: Assuming that you conclude your work in May, which I think is the current proposal, I do not see why there should not be, because, for a start, the Bill would not have left the Commons, and it certainly would not have gone through the Lords. There is lots of opportunity to amend the Bill in the Lords and then come back and debate it in the Commons if there is any controversy about that.

Obviously, there is a premium on making the recommendations public. If they are very substantial, we have to assess them, and we will try to do that as quickly as possible, and then we have a duty to give the industry and anyone else who is interested a chance to have a view on them. I would want to have some sort of consultation on this, but the short answer to your question is: if you report in May, and I agree with the changes, we can get them in the Bill.

Chair: I will pass on to one of their lordships who will be making sure that you are held to that: Nigel Lawson.

Mr Osborne: It is going to be a particularly interesting process in the Lords-if I look at the peers round this table.

Lord Lawson of Blaby: It will be. I suspect that it will be, and I hope you will enjoy it.

Q4398 Chair: There is some heavy artillery there, awaiting your proposals.

Mr Osborne: Indeed.

Q4399 Lord Lawson of Blaby: I would just like, because time is short, to ask two questions on different aspects of this great tapestry. One is going back to the restructuring of Royal Bank of Scotland and all that. In answer to Lord Thurso’s questions and my own, you seemed to indicate that you saw presentational difficulties in this. That surprised me not merely because of your great presentational skills, but because doing something that would significantly help lending to small and medium-sized enterprises-SMEs-and at the same time do something about increasing competition in banking ought not to be too difficult to present, surely.

Mr Osborne: By presentation, I do not mean PR or writing a press release.

Q4400 Lord Lawson of Blaby: No, you would be doing it because it is the right thing to do.

Mr Osborne: We are all Members of Parliament here, of one Chamber or another, and would have to explain to our citizens why we were using billions of pounds of their money-without getting into a partisan debate, I have had to make some very controversial decisions on welfare and the like-in effect saved from welfare in order to buy out minority shareholders in the Royal Bank of Scotland.

Q4401 Lord Lawson of Blaby: Well, that is absurd: it is not the case. You know perfectly well that this is not money that could be used for welfare. For example, supposing you just exchange the minority shares for tradeable warrants-there are a whole lot of things. Any half-decent investment banker could give you half a dozen or a dozen ways of doing this-

Mr Osborne: We have had quite a few unsolicited proposals.

Q4402 Lord Lawson of Blaby: I am sure you have. If this is the right thing to do, you could present it, because this does not make any difference to how much money we can afford to spend on pensions, social security of any kind or whatever. That is complete economic nonsense, and you are well aware of that.

Mr Osborne: It is reasonable to say-let me put it in a more elevated way-that there is fiscal space, as a country. Whether it is a financial transaction or directly purchasing or anything else, you would be using up some of the fiscal space to do this-

Q4403 Lord Lawson of Blaby: No, not so.

Mr Osborne: Yes, you would.

Q4404 Lord Turnbull: Well, you buy these shares in, and it is quickly followed by the sale out. You could even do them on the same day.

Mr Osborne: Hold on. I have a memory of what was said in 2008. I was told-we were all told-"This was the deal of a lifetime". The British taxpayer was buying RBS at rock bottom. We could not help but make billions of pounds. "Lucky old British taxpayer" -that is what we were told and, at the moment, this country is £15 billion or something down on its investment in the Royal Bank of Scotland. I am just saying that, before you just assume it is a great financial transaction that can quickly be flipped, you are taking at least a risk with public money. Let us agree on that.

Q4405 Lord Lawson of Blaby: I will not pursue this further now, because we have not got time.

May I ask you one other question about taxation? May I make it absolutely clear that this is not an attempt to find out what you have in mind for your Budget next month? This is absolutely nothing to do with that, because I know that no Chancellor would dream of answering a question if it were about that. But do you not find it extraordinarily perverse that at a time when it is quite clear-everybody is agreed; the regulators certainly agreed; you were agreed-that the banks relied excessively on debt for financing themselves and had a very small amount of equity capital, and that they need to have more equity capital in relation to the amount of their debt for stability, at the same time we have a tax system that makes it much more economic to raise debt capital than equity capital? Is that not perverse?

Mr Osborne: I certainly accept that it is a feature of our tax system and has been for some time-some decades. A number of independent examinations of our tax system-the Meade report and the Growth Commission from the London School of Economics-have all identified this distortion in our tax system. There are at least two questions that you would have to have in mind for addressing it. The first is the practical impact on the nature of your businesses-not just your banking businesses, but all your businesses, many of which, with legitimate expectations, took out loans and have operated business activity off those loans. So a change could have quite a disruptive impact on businesses.

Secondly, you have to ask yourself what is, at least in theory, the best approach? If you wanted to deal with this distortion, what is the best approach to it? You can either reduce the favourable tax treatment of debt interest or you can increase the favourable tax treatment of equity. So there are at least two methods for addressing the distortion, if you wanted to.

Q4406 Lord Lawson of Blaby: But there is a nonsense there that needs to be looked at.

Mr Osborne: I acknowledge that our system favours debt financing over equity.

Chair: Andy Love really is going to have the last question.

Q4407 Mr Love: I wanted to come back to the point that you answered for Mr McFadden. In your speech in Bournemouth, you encouraged the Commission to come forward with far-reaching proposals. It is likely that those far-reaching proposals will not be ones that we can adopt in an early Bill. Surely you have to give us some reassurance that, if the far-reaching proposals meet with your approval, and after consultation you believe they should go forward, there would be some legislative time made available for them.

Mr Osborne: As I said, I think we have the time to do it in this Banking Bill. I cannot make a promise about the legislative programme, not least because that is a decision of the Cabinet, not me individually. We have a Banking Bill; it is just beginning its passage through one of the Houses of Parliament. Provided the Commission produces its report in a timely way, I do not see why we cannot amend the vehicle we have got. I do not have to say this to you, Mr Love, because you are an experienced hand in Parliament, but promises of future legislation are not worth as much as the fact that we have a Bill, which is going to be in Parliament all this year.

Q4408 Mr Love: We’ll do the far-reaching proposals; you do the rest.

Mr Osborne: Not all of it has to require changes to the law. Some of it can be things on which the leaders of the industry themselves agree.

Chair: We will do our best to report in a timely way. We will certainly bring this session, which we intended to be two hours, to an end in a timely way. Thank you very much, Chancellor. It has been a tough afternoon for you, and we have picked up a good deal.

Mr Osborne: It’s all part of the job.

Prepared 1st March 2013