Economy, Energy and Tourism Committee, 02 Dec 2009

Meeting date: Wednesday, December 2, 2009

Official Report 310KB pdf

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Financial Services Inquiry

I welcome colleagues to the 32nd meeting of the Economy, Energy and Tourism Committee in 2009. We have two items on today's agenda. Later, we will hear from the new chief executive of Scottish Enterprise, Lena Wilson, along with the chairman, Crawford Gillies, on the agency's future proposals, but first we have the continuation of our banking and financial services inquiry. I am pleased to welcome back our adviser, Philip Augar, and I thank him for his helpful advice to the committee throughout the inquiry.

Today, we have one witness: Archie Kane, who is a group executive director with Lloyds Banking Group. I am pleased to welcome him to the committee. I invite him to make some brief opening remarks and then we will open the questioning.

Thank you, convener. I thank the committee for inviting me to speak to it today. Lloyds Banking Group is happy to take part in the inquiry, as it examines how the future shape of financial services affects Scotland.

There is no doubt that Scotland suffered when HBOS and the Royal Bank of Scotland got into difficulties in 2008. The circumstances behind those difficulties have been well documented and clearly articulated. They had a significant impact, but Scotland's fundamental reputation as a strong financial centre remains intact.

It is important to bear in mind that the financial sector in Scotland is not simply banking. The insurance and fund management sectors in Scotland are very robust. They have deep and wide pools of talent and have come through the crisis in remarkably good shape.

I was part of the Treasury's financial services global competitiveness group. One of that group's findings was the strength of financial services throughout the United Kingdom, not only in London and particularly in Edinburgh. I still firmly believe that a strong and growing financial sector is not only important to Scotland but vital to the economy as a whole.

Scotland plays a significant part in Lloyds Banking Group. We are one of the largest private sector employers in the country, with more than 20,000 staff throughout Scotland; our registered office is on the Mound here in Edinburgh; and we hold our annual general meetings in Scotland. A large number of the group brands are based in, and run from, Scotland. The Bank of Scotland, Scottish Widows and Scottish Widows Investment Partnership are some examples of those brands.

As the main board director with responsibility for the group in Scotland, I established the Scottish executive committee, which meets monthly in our office on the Mound and brings together senior executives from throughout the group in Scotland at managing director level to consider matters from the group perspective in Scotland.

Lloyds Banking Group has been in receipt of state support and the Government owns 43 per cent of the company's common equity. The recent announcement about our capital raising, which our shareholders approved last week, gives us a good platform on which to build Lloyds as a stand-alone business eventually. I acknowledge that the level of Government support comes with great responsibility to our customers, colleagues and the community at large. We in the banking world have to learn from what happened recently. I understand that not everybody agreed with the merger of Lloyds TSB and HBOS, but I believe that the new enlarged group will deliver long-term value for our shareholders and am committed to ensuring that Scotland is proud of the company, which has great Scottish brands such as the Bank of Scotland at its core.

I would be happy to take questions.

Thank you very much for those opening remarks. I will explore a couple of points with you to clarify where the Scottish operations sit within the Lloyds Banking Group structure. First, will you explain your own position a bit more? What is your current role within the group and where do you sit within the corporate structure?

I am a main board director of Lloyds Banking Group. I have been in the company for almost 24 years, from the Trustee Savings Bank through Lloyds TSB to Lloyds Banking Group. I have been on the board for almost 10 years and am the longest serving main board director. I am responsible for the insurance group of businesses within the group. There are four operating divisions within the group: retail banking; wholesale banking; wealth and international; and insurance.

Insurance comprises such brand names as Scottish Widows, Clerical Medical and Halifax Life. There is a bunch of general insurance businesses as well. When we aggregate all our insurance businesses, we are the biggest insurance company operating in the UK. The division is headquartered in Edinburgh, where the executives meet monthly. About 70 per cent of the top executives are resident in, or operate from, Edinburgh. The headquarters of the division is therefore in Edinburgh.

I also have responsibility at main board level for Scotland across all lines of business—all the banking, asset finance and so on. To meet that responsibility, I constituted the Scottish executive committee, to which I referred in my preamble, which consists of about 14 or 15 executives at managing director level—they are very senior people. For example, Philip Grant, the chief operating officer of the wholesale bank, who is based in Edinburgh, sits on the committee, as do Susan Rice, whom I appointed as managing director of Lloyds Banking Group in Scotland, and Caroline Booth, the worldwide head of purchasing and procurement for the whole group, who lives in and operates out of Edinburgh. Those are the type of people whom I have on that committee, which meets monthly and operates from the Mound. I therefore have a dual responsibility for the insurance businesses and for all the businesses in Scotland.

You mentioned that the registered office for the group would be in Scotland. What functions does the registered office have?

The registered office has just been moved to the Mound this week, I think. It used to be in Henry Duncan house with the Lloyds TSB group. Certain legal and company secretarial functions reside in the Mound, as well as the insurance businesses and a range of other activities. Perhaps I should just explain a bit about the Mound. We have based our Scottish headquarters, which includes many of the things that I have discussed, on the Mound. However, we are running out of space on the Mound, which is an active and vibrant place. I am told that that is different from how it was prior to the acquisition. In fact, when I arrived on day one of the acquisition of HBOS, the building was fairly empty. I can reassure members that it is now a very active and vibrant place. The biggest problem now is trying to find space for people to fit into it. We have plenty of other offices in Edinburgh, so I am sure that we will be able to deploy people. However, the dynamic on the Mound has changed significantly.

Just to clarify, is the building on the Mound the registered office for the whole Lloyds Banking Group or just for the Scottish operations?

It is for the whole group, so we hold our annual general meetings in Scotland. Over recent years, they have been in Glasgow, and they were in Edinburgh prior to that. That was the case in the Lloyds TSB world as well as in the Lloyds Banking Group world.

Was the last AGM not in Birmingham?

We had a general meeting, not an annual general meeting, in Birmingham, which was for the rights issue that took place last week. As you will probably know, the meeting was held at very short notice because of the discussions with the Government over the asset protection scheme and our decision to have the rights issue. Despite various attempts, we could not find a venue elsewhere at short notice that was big enough to accommodate us, so the meeting was held in Birmingham.

But the main corporate headquarters for the group as a whole is in London.

The Lloyds Banking Group headquarters is in London. They have always been there and we indicated that that will continue to be the case. I spend some time in London and some time in Edinburgh.

You mentioned Susan Rice. We read in the papers recently that her role is changing. Is that the case?

Yes. Susan Rice was for a number of years chief executive of Lloyds TSB Scotland, which was a subsidiary of Lloyds TSB. When we started to pull all the businesses together following the acquisition, I asked her whether she would accept the role of managing director of Lloyds Banking Group in Scotland, which of course has a far greater and wider remit. I am very pleased to say that Susan took up that appointment. She has moved into the Mound building and is now working there with a small team. As part of that appointment, she had to relinquish her position in Lloyds TSB Scotland, which is a fairly small part of our operations in Scotland. You probably read that, as part of our discussions with Brussels and as a result of the state aid negotiations, we will have to dispose of Lloyds TSB Scotland along with a portfolio of other businesses throughout the UK.

I have a final question on the structure and management of the Bank of Scotland operations and the Lloyds TSB branches in Scotland. Where are the key decisions taken on that? Are they taken in Scotland?

Peter Navin is responsible for Scotland and all the branches in Scotland. He operates in Scotland and covers all those branches. He has a team that focuses on the branch networks in Scotland, which currently are the Lloyds TSB Scotland and Bank of Scotland networks. That is all run within Scotland. He then reports down to London to a colleague of mine, Helen Weir, who is the group executive director in charge of the whole of the retail bank.

Our inquiry remit covers the future of Scottish financial services, but it is important that we get your perspective on how we got to where we are. You mentioned the observable change on the Mound between the time when HBOS was there and the present day. You have already seen some changes worked through. Will you briefly give us your view of what the cardinal failures were at HBOS and what the principal reasons were for its getting into such a position?

I was not a director or member of the executive of HBOS, so I cannot give you deep or private insight into what happened there. If we consider what happened during the financial crisis, particularly at the end of 2008, we find that banks throughout the world got into difficulties, so that was not peculiar to the UK or Scotland. Clearly, HBOS was one of those banks. Right from the start of our involvement with HBOS, we have applied our risk models and our risk appetite—the areas and types of business with which we will operate. Businesses have to meet certain criteria to meet our risk appetite. It is clear that HBOS's operating model and its approach to risk were different from ours.

Sometimes the inference is drawn that there was a problem in Scotland. It is important to say that my view is that the issues that impacted on the two big Scottish banks were more to do with the operating models that the banks used than with anything intrinsic to or endemic in Scotland and the Scottish economy. Banks in virtually every jurisdiction in the world ended up having problems—we could look at Fortis, Commerzbank and ING. Fundamentally, the issue comes down to the operating model that those institutions used.

Representatives of UK Financial Investments came to see us a couple of weeks ago. To paraphrase their evidence, they said that the Royal Bank of Scotland suffered from an institutional bias in favour of growth and acquisition rather than value, and that HBOS suffered from a culture of risk taking that had lost touch with the value base on which judgments should have been made. In essence, there were two faulty operating models and it was coincidental that they were both banks with a substantial base in Scotland. Is that in line with your analysis?

I agree with that.

What did you find when Lloyds TSB took over HBOS? Clearly, the decision to merge with HBOS must have been a difficult decision because people would have been aware of the problems in HBOS. After the merger, did you find what you expected to find?

We did a huge amount of due diligence before we acquired HBOS. In fact, we did everything that we could legally do as one public company dealing with another public company. We were aware of the problems, particularly in the commercial and corporate lending markets. What we did not predict—very few people did—was the steep and rapid decline of the economy in quarter 4 last year and into this year. When a bank has big lending books, a rapid decline in the economy has an impact on impairments and bad debt provisions. That is the one thing that we probably underestimated. However, we were not alone in forming that view.

When we took over HBOS, we found that the risk culture and the approach to risk were not the same as we would expect in our own organisation. Perhaps some of the management information was not as strong as we would expect in our own institution. Clearly, some decision making was handled in a fashion that would not have been our way. Those are the types of things that we found. However, from day one, we have applied our own risk modelling and risk reporting. We have investigated all the books on a file-by-file or case-by-case basis, so we now have a pretty good handle on the situation, the level of exposure and what activities fall within our risk appetite. As regards those bits that fall outwith our risk appetite, we are working our way carefully through with those clients to find sustainable long-term solutions as we go forward.

I assume that you also found low morale, especially when it became clear that HBOS had rapidly lost value. How have you gone about changing the culture among the staff you acquired through the merger, especially among those who were responsible for, or involved in, the faulty decision-making processes? To what extent have they accepted and endorsed the change in direction and culture in the business?

Clearly, morale is a key issue when dealing with large numbers of colleagues and staff. However, a quite interesting and peculiar phenomenon was that, perhaps because morale had gone down a great deal towards the end of 2008 as the problems of HBOS became manifest, there was a sense of relief when the takeover deal was done. That was the feedback that we kept getting back from the line management in the HBOS companies. Of course, as we went into the difficulties of the economic crisis and had to face up to the issues confronting Lloyds Banking Group, we had to rebuild morale not only on the HBOS side but on the Lloyds TSB side. Morale, communication with staff and motivation of staff are key issues as we go through difficult times.

I have great sympathy for the staff. We are going through a large and complex integration of two very large organisations. That creates uncertainty for staff. Having run the whole merger when Lloyds and TSB got together, I am very aware of the impact that integration has on staff. The issue affects staff from both heritages—both HBOS staff and Lloyds TSB staff—so we want to get through that as quickly as possible. Obviously, communication is key. We need to clarify the future as quickly as possible by working through the various projects, laying out the strategy and explaining to people how things will operate in terms of jobs and so on.

The merger of Lloyds and the TSB was clearly driven primarily by commercial considerations. Was the merger of Lloyds TSB with HBOS primarily a commercial decision or was it a patriotic act?

The Lloyds TSB board had to operate on behalf of its shareholders. We had to consider the merger as a commercial decision. The caveat to that answer is that it is evident that we would not have been able to take over HBOS if it had not been in trouble. We would also not have been able to take over HBOS if the Government had not been prepared to waive the normal competition rules. We could not have become trammelled in a long-term competition review because the share price of both banks would have been vulnerable. That is evident and there is no point in trying to hide from the fact, but we had to consider the merger on a commercial basis. When we made the decision, we did it on a commercial basis and we still believe that, in the fullness of time, it will be seen to be a strong commercial case.

It is evident that we have some short-term difficulties to work through. However, I point to the almost unanimous—more than 99 per cent—shareholder vote in favour of the rights issue last week. That would not have happened if we did not have a viable strategy and the investors did not believe in the company's future; otherwise, they simply would not have subscribed to that rights issue.

How important was the emergency liquidity assistance in that judgment? Was it critical to your decision and the success of the acquisition?

You refer to central bank liquidity assistance. It is important to remember what was going on at the time. Towards the end of 2008, Lehman Brothers was failing and Northern Rock failed and was completely taken over by the Government. There was serious concern about financial stability throughout capitalist western society. Central banks in all those jurisdictions made special liquidity arrangements available to the banks in their jurisdictions. What happened in the UK was no different from what happened in many other jurisdictions. In fact, we have availed ourselves of some of the central bank liquidity wherever we operate, such as the liquidity in the US and from the European Central Bank. What the Bank of England did in 2008 and has subsequently done is entirely in keeping with a central bank's role as a lender of last resort.

Liquidity was an issue. There was a complete shortage of liquidity. The credit crunch means that banks stop lending to one another. In those cases, central banks have to step into the breach to ensure financial stability. Financial instability was a real worry and a real threat. That was without doubt a backdrop to everything that took place.

Mr Kane, in the autumn of 2008, was HBOS in any state to remain as a viable independent entity?

It is clear now that HBOS could not have survived on its own. It was finished as an entity.

I am struck by the extent to which you have dwelt this morning on the concerns about HBOS's operating model, its appetite for risk, and the quality of its management information and decision making. Do I take it from that that you believe that it was brought low by its own strategy, rather than by the reactions of the markets—spivs and speculators, as they were dubbed at the time?

It is evident that HBOS pursued a particular operating model and had a particular approach to risk that were different from those of other banks. Therefore, when the liquidity crisis hit, it was more vulnerable than other institutions. We look back now from the position of a much more stable regime. The financial sector is much more stable now because what the UK and other Governments did was appropriate and has done the job. As we look back and the dust settles, it is clear that some institutions got through the crisis because they had different operating models and approaches to risk and some did not.

Given all that, what are the benefits to Lloyds of the HBOS business?

HBOS had a range of businesses. It had a very good retail franchise, particularly the Bank of Scotland, which is an excellent retail franchise. It had a range of insurance businesses, for which I am now responsible, which we are rapidly developing and integrating. It had a large exposure to the small and medium-sized business sector. It had some issues on the corporate side that have to be worked through—I think that they have been well publicised and are understood now. It also had Halifax, which is the premium mortgage bank in the UK. HBOS therefore had a range of different businesses, not all of which were in trouble and some of which were in very good shape. It was the aggregation of the risk that was the problem. That is why we believe that, once we get through the short-term problems, we will have a very strong financial entity that will help us to move forward.

The phrase "short-term problems" is perhaps slightly euphemistic, given the scale of support that has been offered. Will you confirm that you were asked in writing in advance to tell the committee how much taxpayer-funded support the Lloyds Banking Group has received in the past 14 months, and could you explain to us why that information has not been provided?

I am very happy to give you the numbers, if that cuts through to the issue that you are after. The Government put just over £17 billion of funds into the common equity of the new Lloyds Banking Group. There have been various pluses and minuses in the sense of money back and money out, but the net amount of cash flow, if you like, that the Government has invested in Lloyds Banking Group is about £17 billion.

What has been the maximum extent to which, at any point in the past 18 months, you have made use of the credit guarantee scheme, the special liquidity scheme and the asset protection scheme?

Let me take the last one first. The asset protection scheme was offered in March 2009. At that point, we and RBS intimated that we would participate in the asset protection scheme. There was a clear reason for doing that. Quite frankly, the capital markets were closed at that point. We had no real alternative and no other place to go to get funding. As we worked through the summer and engaged in detail with the asset protection scheme, we came to the conclusion that it simply was not appropriate for us to enter into the scheme. However, we had to have an alternative. The alternative is the rights issue, which is a combination of common equity and a conversion of debt, which amounts to £22 billion-plus—the biggest of its kind in history. We can do that now because the markets are supportive. We believe that the rights issue is a much better solution and that it will accelerate the move of Lloyds Banking Group to being an independent entity, standing on its own two feet. That is our firm intention and objective.

We have therefore never drawn down anything from the asset protection scheme. Having said that, we have paid £2.5 billion to the Government. The reason for that is as follows: the Government and Brussels took the view that the fact that the asset protection scheme was made available to us gave an underpinning to the organisation that was implied insurance or implied state aid. We engaged in negotiations with those two parties, and engaged independent advisers on what the range of the value was. The Government had its range of value, and we met somewhere in the middle on the figure of £2.5 billion.

What was the implicit sum assured, which the £2.5 billion covered?

The figure that we initially spoke about was some £260 billion of assets that we would have potentially put into the asset protection scheme. It is probably unlikely that it would have ended up at that number—it would have moved around. However, that was the initial figure that we used.

Could you give us comparable figures for the credit guarantee scheme and the special liquidity scheme?

As you know, Mervyn King recently mentioned at the Treasury Select Committee that RBS and HBOS had received special liquidity arrangements from the Bank of England towards the end of 2008. For HBOS, that peaked some time in November 2008 and was paid back prior to the acquisition on 19 January—the figure was about £25 billion. Let me be clear that we, along with all other banks, continue to access the liquidity schemes from the central bank. Under the rules of the schemes, we cannot divulge at any point in time the amount that we take through them. The amount varies from time to time, depending on issues such as how the institution is moving, how much debt is paid back and how much lending we put into the economy. However, that is no different from the situation in any other country. In fact, as I said earlier, we access liquidity in a similar manner from the European Central Bank and the Federal Reserve in the US. Similarly, the rules are that we cannot divulge the sums at any particular point in time.

What about access to the credit guarantee scheme?

That happens on a similar basis. I do not have the exact numbers.

It would be helpful if you could write to us with a summation. As a banker, you will understand that parliamentarians, as the stewards of the public purse, would like to record the full exposure of the taxpayer in supporting individual institutions in the past 14 months. For the record, those figures would be of interest to the committee.

I am happy to write to you with information, in so far as I can divulge it.

I am happy with that.

I have one final question. Last week, the City minister, Lord Myners, said that the Lloyds Banking Group board was fully aware of the loans that were made under the emergency liquidity assistance scheme. Is that your recollection as a member of the Lloyds board?

I assume that you are talking about the funds that had been advanced to HBOS prior to the acquisition.

I am talking about the emergency liquidity assistance. Lord Myners clarified that the entire board was made aware at the time.

We were aware that significant funds had been advanced to HBOS. In fact, the prospectus that HBOS put out and the one that we put out specifically drew attention to the fact that funds had been provided and that they would continue to be provided. However, we could not talk about specific numbers, as the rules do not allow that. I guess that the concern at that time was about financial stability. In retrospect, it is understandable that there was concern not to create additional worries and to try to get through the difficulties.

In a hypothetical situation, if somebody at the AGM last November or December asked how much use you had made of the scheme, the answer would have been, "We can't tell you."

Yes. We had a general meeting last week and we had similar questions. The chairman and chief executive were clear that we avail ourselves of the liquidity schemes, as does every other bank. That is not peculiar to us or to state aided banks; all banks can avail themselves of such schemes and do so to a greater or lesser extent. They do it in other jurisdictions as well. The rules are that we cannot divulge the extent to which we access the schemes.

About 14 months ago, the Office of Fair Trading had concerns about the takeover's impact on UK-wide competition in relation to personal current accounts and mortgages, and on lending to SMEs, particularly in Scotland. Was the OFT justified in its concerns?

The OFT and the competition authorities have a duty constantly to monitor to ensure that competition operates appropriately in all markets throughout the UK. Frankly, that is welcome and sensible. We welcome competition, as it is a good thing. From time to time, investigations are mounted.

The banking and financial services market in the UK is highly competitive. Recently, there has been a change in the type of player in it. A number of the entrants—foreign entrants in particular—that came into the market and created a lot of the competition shut up shop and disappeared when the going got tough as a result of the financial crisis. There is nothing that can be done about that. If companies decide to withdraw from a market, they cannot be forced to stay, particularly if they are incapable of staying. Equally, there is still a large number of players in the mortgage market and in excess of 100 different institutions play in the savings and investments markets in the UK. The market is highly competitive. It will wax and wane over time and the backdrop of the economy will play a part in that.

Are you aware of any dialogue with, or investigations by, the OFT in relation to personal current accounts, mortgages or SMEs within Scotland?

You will be aware of the current account charging decision that the Supreme Court handed down recently. The OFT was fully involved in that. That is an example of an area in which it was fully engaged, but I am not aware of other significant OFT investigations that would have a particular impact on Scotland.

Are you aware of any specific Scottish work that it is doing?

I cannot bring to mind anything, although that does not mean to say that it is not doing work in Scotland.

Is Lloyds Banking Group taking any steps to try to ensure that the marketplace in Scotland is as competitive as possible?

Yes. We intend to be a competitive force within Scotland. That means that we will have to have products that are fit for purpose and those products will have to be priced competitively. Our primary brand in Scotland will be the Bank of Scotland. I mentioned earlier the difficulties that HBOS had in surviving on its own. You must realise that it had basically shut down in the corporate and SME market in 2008. It was simply not operating because it had run out of liquidity and funds.

We are now breathing life back into the Bank of Scotland. It is up and running and is open for business. It is competing in the SME market and across the full range of its product set. We intend the Bank of Scotland to be a strong, competitive force within Scotland.

As part of the resolution of the state aid negotiations with Brussels, we have had to come to an agreement whereby we have to dispose of certain parts of our business. I make it clear that that is painful. Nobody likes to dispose of parts of their business. It is hard to gain business and market share—companies compete strongly for it and defend it as best they possibly can—so it is difficult to dispose of parts of the business. However, we have come to an agreement with Brussels and, as part of that, Lloyds TSB Scotland will be divested of, as part of the portfolio of businesses that we will put together. That will take with it a significant chunk of the personal current account market in Scotland and a proportion of the SME market in Scotland. It is unclear how that will eventually land. We do not know who will buy Lloyds TSB Scotland or whether it will be floated off. We have four years to work our way through that. However, one thing is clear: it will be a separate competitive force. That, in and of itself, resolves some of the concerns that might have prevailed.

Let us drill down into the SME market. MSPs get a lot of correspondence from SMEs. Roughly what percentage share of the SME market does Lloyds Banking Group have in Scotland?

About 30 per cent. It is not the biggest player in Scotland. That is about where we are.

Roughly what impact would the divestment of Lloyds TSB have on that percentage?

The impact would probably be in the region of 10 per cent plus—it would probably be somewhere between 10 and 13 or 14 per cent. Lloyds TSB Scotland's percentage is much smaller.

Just so that I have got things right—

I am talking about start-ups. With respect to the existing book, the total share is around 30 per cent. Lloyds TSB Scotland's percentage would be smaller—it would be 9 to 10 per cent of the existing book.

I want to be absolutely clear. Would Lloyds Banking Group's market share of 30 per cent—give or take a percentage point or two—drop down to 27 per cent or to 20 per cent?

It would drop to about 20 or 21 per cent of the existing book. I am talking about the total market share. I was initially talking about new business, as we tend to focus on new business. Those are the figures for the actual market share.

How have your lending policies to SMEs in Scotland changed? Roughly, has the percentage of SMEs that you have been able to say yes to changed over the past couple of years, say? Has net new lending changed?

I must deal with the question in two halves. Lloyds TSB Scotland has increased its lending over the difficult time. In 2008, it significantly increased its lending to the SME sector by somewhere in the range of 15 to 18 per cent year on year. The Bank of Scotland declined during that period. Earlier, I mentioned that it was basically shut for business because of liquidity and funding problems, but we have opened up again and the bank is now active.

In the period from June this year, we have increased overall lending in the SME sector in Scotland by about 10 per cent. That has been done by bringing the Bank of Scotland back online and building up the pipeline, which takes a while. When I talk about SMEs, I mean businesses with a turnover of up to £15 million. We have started to rebuild the business pipelines.

We continue to have application conversion rates that are slightly in excess of 80 per cent. The figure varies, but it has not dropped below 80 per cent. We have definitely seen a drop in demand—that is, in the applications that we have received. There has probably been a year-on-year drop in demand of around 20 per cent.

We also carefully monitor the commitments that we have out there. The quantum of commitments that have not been drawn down is around 25 per cent. A significant amount of credit has been agreed and is available to the SME sector, but it has not been drawn down. There is an important reason for that. A large number of businesses have been destocking and paying back, or reducing, their debts. The level of repayments is significant.

You refer to a drop in demand and funds that have been agreed but not drawn down. How do you think Lloyds Banking Group as a whole will do against Government targets for lending to businesses?

We have agreed with the Government that we will seek to deploy an additional £28 billion over two years—£14 billion per annum. The split of that is about £3 billion on the mortgage market and about £11 billion across the various sectors of the commercial market. The mortgage market is going fine. The difficulty, which is in the corporate and commercial sector, is in finding the demand, which is not as robust as it was in previous times. That is a challenge for us, but we are intent on trying to be available and to access businesses that are out there.

In the SME market this year, we have written to all our SME customers to indicate the services that we have available and that we are open for business. By the end of this year, we will have physically contacted all our SME customers to say that we are open for business. The reason why we are doing that is that it is quite evident that, given that the Bank of Scotland has gone through that difficult period, a number of customers might have formed the view that it was not really interested in participating in that market. It is very important that we get out there and communicate with customers. That is why we have that big programme.

We are also holding about 200 seminars per annum for small businesses and start-up businesses to try to explain to them what services we have available, how we can help them and how they can access our facilities. That is a new initiative that we have put into the marketplace. There is really quite a lot of activity in and around lending to the corporate and SME sector.

Business organisations have told us that they are not applying for loans, not because they do not need the money, but because the conditions that the banks are imposing are such that businesses know that they will not get a loan. There is a view that some of the banks wish to reduce their exposure to property because they have been overexposed to it in the past. The fees that have been applied—either up-front fees or exit fees when the loan comes to an end—mean that businesses are simply not applying for loans. The 20 per cent drop in demand is not a result of there not being a need out there. People are not applying for loans because they know that they will not get them or because they cannot afford them.

The reason why I mentioned the communication programme, the seminars and communication with customers is that we understand that there might be a perception out there that the banks—and our bank in particular—may not be interested or "open for business". That is not the case. Our application conversion rate has not changed. We still convert more than 80 per cent of the applications that we get into loans. That has been relatively consistent for a period of time.

Let me be clear: there are sectors, and businesses within sectors, that might not meet the appropriate credit criteria, so there will be cases that we turn down. At the end of the day, banks want their clients to succeed and survive. Banks lend money with the full intention of getting it back one day. There will be businesses that do not meet the criteria because of their operating model or risk structure. It is important to understand that and to be realistic about it. The intention of Lloyds Banking Group, particularly through the Bank of Scotland, which we are trying to breathe life back into, is to make it clear that we are open for business and that, in the corporate and SME market in particular, we are keen to do business with our existing customers and with new customers.

Good morning, Mr Kane. I want to move on to areas that you consider to be strong—insurance and asset management. You said in your submission:

"Scotland remains a strong player in global finance. Firms in the insurance and asset management area have largely come through the recent crisis in good shape".

Indeed, you said in your opening remarks that they had come through in remarkably good shape. Will you say a bit more about the insurance division as based in Scotland?

The Lloyds Banking Group insurance division consists of Scottish Widows, Clerical Medical, Halifax Life and a range of other smaller brands, and Lloyds TSB General Insurance and Halifax General Insurance. The headquarters of those businesses are on the Mound, as I articulated earlier, but they operate throughout the UK. Some businesses are based elsewhere. For example, our general insurance businesses are based in south Wales and Yorkshire, so we run those general insurance businesses from two hubs. Our life and pensions businesses are based in Edinburgh and Bristol. Those are the two primary hubs that we operate.

Our life and pensions businesses are number one in market share for the UK and are particularly strong in the insurance bond markets and mutual funds. We are also very strong in the pensions market and, to a lesser extent, in the annuities market. We therefore operate across the key, core, long-term savings markets throughout the UK.

Our general insurance businesses are about number three in distribution across the UK. We operate mainly in the home insurance and creditor insurance markets, although we also distribute motor insurance and so on. We are therefore a significant player in the life insurance and general insurance markets. Our headquarters for those businesses is on the Mound, so the finance director, I, the risk director and the human resources director operate from the Mound to run those businesses. I am also one of the managing directors of the biggest bit of Scottish Widows, which is clearly based in Edinburgh.

How much of the insurance division is Scottish Widows?

Scottish Widows is the primary life and pensions business. In fact, we have announced the decision that that will be the predominant brand of our life and pensions business in future. We have combined the sales forces of the bank insurance sector and the independent financial adviser portion of the market, and rebranded at Scottish Widows.

How many of the 20,000 employees in Scotland are in the insurance business, and how many of those are in Scottish Widows?

Of the 20,000, about 3,500 are in the Scottish Widows life and pensions business, which is virtually all Scottish Widows.

It is important to see how that might be a future player. Do you envisage it expanding its role to a greater extent than any other element or division?

I fully intend the insurance businesses to grow. The insurance market is quite fragmented. Although we are number one, market share varies between 10 per cent and 16 or 17 per cent in the various individual product markets. There are therefore no restrictions on trying to grow those businesses, and we fully intend to grow them. If we think about it from the point of view of Scotland, having the headquarters of the biggest life company in Britain in Edinburgh is quite a new thing.

Indeed. Turning to asset management, and thinking about it as a strong, Scotland-based business, you are collating part of your business into the SWIP brand. Can you tell me a bit more about the size of SWIP and how it is organised in Scotland?

Yes. When we took over HBOS, it had its own fund manager called Insight Investment Management. You have probably read that Insight has been disposed of and sold to the Bank of New York Mellon Corporation. Insight handled a large proportion of the internal funds, that is, the funds coming from the insurance and savings activities in HBOS. As part of that disposal, we are transferring all those funds from Insight, which was based in London, to SWIP, which is in Edinburgh. SWIP will therefore end up with some £120 billion to £125 billion of funds, which will make it one of the biggest fund managers in the UK. It is based in Edinburgh and run from Edinburgh—it is a Scottish institution.

SWIP's role in your group is clear. In the context of the company's potential, how many people are employed in SWIP?

I used to run SWIP—I used to be chairman, but I have not been chairman for a little time. I think that SWIP has about 400 people based in Edinburgh. Fund managers are small in terms of the number of people, but SWIP is a big fund manager and will probably expand. I am not up to date on the exact numbers that SWIP has, but the figure is of that order.

Small but specialised as SWIP is, do you expect it to grow?

Yes—

Will there be more jobs in Edinburgh?

I expect SWIP to grow. We are talking about sophisticated, high-end jobs. The fund management sector is a deeply skilled environment. I expect it to grow because, among other things, I intend to grow the insurance businesses, which are a significant feed of funds into the fund management business.

Are you in asset servicing on SWIP?

We outsource our back office to, for example, State Street, which is also based in Scotland. We have a big outsourcing deal with State Street.

Why?

Because we have decided to focus our activities on the areas in which we think that we can add value and we think that the back office is best done by someone else. We make those decisions across all our businesses and across the value chain in all our businesses, on the basis of whether we think that we can create value. For example, in the general insurance businesses we think that we have real competitive advantage, so we do claims handling ourselves; in other businesses we pass functions to people whom we think can do them better and more economically than we can do them.

Before we move on, do you have an interest in buying any of the RBS insurance businesses that have to be divested? Would you be allowed to bid for those businesses under European Union rules?

I am not entirely sure whether the EU rules would allow that, but I must say that we have no particular interest in or intentions in relation to the RBS insurance businesses.

May I take you back to your earlier comments? Do you feel that you are running a Scottish business or a business that is part of a larger group?

It is quite evident that we are part of a larger group, so it would be foolhardy to pretend otherwise. I run the insurance businesses, but they are part of a larger group, and I am responsible for Scotland, as part of the Lloyds Banking Group. The business is part of a larger group, but the group takes Scotland very seriously—it is a significant part of the group's business. I personally take that seriously. I am Scottish and I have lived and worked abroad and travelled extensively; now I am back home.

I regard the role that Lloyds Banking Group plays in re-establishing its business and in helping the Scottish financial sector to recover from the difficult period as an important role on which to focus. The two objectives are goal congruent. The return of the financial sector in Scotland and the prosperity of Lloyds Banking Group are part of the same agenda. I am very interested in the development of the financial sector in Scotland and of Lloyds Banking Group as it operates in Scotland. If the Scottish economy does not do well, there must be an impact on Lloyds Banking Group in Scotland. If it recovers and does well, Lloyds Banking Group will do well, if it competes properly, as we intend it to do.

You said that the Bank of Scotland is a primary brand in the group, which you want to be more open for business in the SME sector. Could the Bank of Scotland run as a separate entity at some point?

That is a hypothetical question. We are focused on trying to revive the Bank of Scotland brand and believe that we have taken some pretty good steps forward, but we have a lot of work to do. Our intention is that the Bank of Scotland will be a key brand within the Lloyds Banking Group portfolio. That is our focus; we do not think about anything outside of that.

Do you envisage the Bank of Scotland being focused solely on Scotland or will it be a UK-wide institution?

Our primary focus is for the Bank of Scotland to be a Scottish brand that operates within Scotland. The other brands that will operate throughout the UK in the retail and commercial banking space will be Lloyds TSB and Halifax. They will be deployed in other areas throughout the UK. That is our focus and intent at this time.

In your original submission to the committee, and in some of your earlier comments, you mentioned that around one fifth of the top 500 Lloyds Banking Group executives work in Scotland. I assume that those people are focused within Edinburgh and the Edinburgh area.

Yes, and Glasgow.

You said that AGMs would still take place in Scotland. Will other senior meetings primarily take place within Scotland or will they be elsewhere as well? I am thinking about the amount of travel throughout the UK that executives will need to do.

The first thing to say is that we travel quite a bit, as Lloyds Banking Group is a large institution. I spend far too much of my time in the air, to be frank. I would rather not, but I have to do that. That said, a range of meetings take place in Scotland. There are the AGMs, which you mentioned, and the Scottish executive committee, which meets monthly in our offices on the Mound. The Scottish Widows board meetings take place in Scotland all the time. Black Horse asset finance is another brand that is run from Scotland; its board and executive committee meet and operate in Scotland. SWIP management and its board meet and operate in Scotland. Indeed, I used to be the chairman of SWIP, and we always met in Edinburgh; that will continue. There will also be a Scottish retail banking organisation, which will be run and will operate from here.

A considerable number of high-level committees will meet and operate within Scotland. However, the executives who are involved in those will, from time to time, have to commute to meetings that take place elsewhere. I am a member of the Lloyds Banking Group main board and have to attend that board when it meets. In recent times, it has met more often than not because of the problems that we have had, although I hope that that will calm down. No matter what sector they are in, any executive who runs a significantly sized business in Scotland and has business outside Scotland will travel quite a bit.

What percentage or ratio of senior-level meetings and business operations takes place within Scotland compared with the rest of the UK?

I would struggle to give you a fact-based answer on the percentage of meetings that are held in Scotland versus the percentage of meetings that are held elsewhere. I have never focused on that, but I go back to the fact that 20 per cent of the top 500 executives in the group are based in Scotland. That is an extremely healthy representation.

I also go back to the fact that our office on the Mound is now extremely busy with constant meetings. I do not know whether you know it, but the Bryce hall—the big hall at the centre of the Mound—is constantly booked for conferences and get-togethers. A number of those are senior HR conferences held by people based in London. A group operations conference was held recently on the Mound, and people came to Edinburgh for it. Those conferences are held on the premises, with a view to the current economic circumstances. A number of events that would previously have been held elsewhere, such as Birmingham or London, are taking place on the Mound in Edinburgh. That is a good thing.

I have questions about employment. You said that 20,000 staff are employed in Scotland, and that 20 per cent of the top senior executives are based in Scotland. I know that you will be unable to give us exact numbers, but what kind of functions are the others involved in?

Do you mean other executives or just the general population?

Just give us an idea of the general trends in Scotland.

The primary employer is the retail banking operation and the network. We have 480-plus branches, which employ large numbers of people throughout Scotland. We also have a large corporate banking operation, and I have mentioned the insurance operation, which employs 3,500 people. We have fund management businesses, information technology support services, administration services and so on. The retail bank is the predominant employer, followed by the wholesale bank, then the insurance division, and so on into group functions.

In your submission, you talk about the restructuring, and you say that it will take two to three years to complete. So far, you have saved £100 million, which has had an impact on staffing levels throughout the group, including in Scotland, of course. Where have the job losses taken place within the group? Where might future job losses occur?

Up until October, we had announced that 1,000 jobs would go in Scotland. They have come primarily from the retail bank, group operations and the insurance division. Those areas have been the three primary drivers, with some losses in the wholesale bank as well—the corporate and commercial bank. The jobs have come out of different parts of the group.

We are just short of a year into an integration that will take two to three years, so although we are quite advanced in what we are doing, we still have quite a long way to go. In November, we tried to look forward to the end of 2010 for the projects that we felt were sufficiently advanced. We announced further job losses through to the end of 2010 in group operations—insurance in particular, in Scotland—which will be another 500-plus jobs, but that will be all the way through to the end of 2010. We have tried to give as much notice as possible, but that does not mean that that will be the end of it. There will be projects in other parts of the business as we go forward.

You also say in your submission that you have good relations with the trade unions, so I take it that there are on-going discussions with them.

Yes. We have three extremely active trade unions: Accord, Unite and LTU—the Lloyds TSB Group Union. We have regular and on-going discussions with the unions on all issues to do with staff and staff conditions. There is weekly communication—in fact, probably more often than weekly—and there is a formal monthly meeting. However, the key functions, such as human resources and the industrial relations part of HR, are constantly in discussion and negotiations with all the trade unions. We have an open and adult dialogue with them.

The unions are important in what we are doing. We are trying to integrate the businesses, so it is important that we discuss with them anything that impacts on staff, whether that is in relation to jobs or to staff terms and conditions. It is important that we have that constant dialogue and subsequent dialogue with the staff.

On a more positive note, what are your expansion and relocation plans?

As I mentioned before, I hope that we will be able to expand the insurance division. We are definitely intending to expand other parts of the group—our wealth and international operation has a clear expansionist strategy. The retail bank will seek to cross-sell more products to its customers, as will the wholesale bank. We will try to expand all those businesses.

As we go through the rationalisation of the businesses we tend to focus on what I described earlier as hubs. In other words, Edinburgh is a significant hub for our insurance businesses. We will coalesce around the hub in Edinburgh. We will also have a hub in Bristol for our insurance businesses.

For things such as business continuity planning, we have to try to split our key activities—for obvious reasons, we cannot have them all in one place in this risky world. We have to have back-up and support and we have to be able to move in real time from one hub to the other. We will do that with our life businesses in Edinburgh and with our insurance businesses in Bristol, Newport in south Wales and Leeds because that is where those businesses were based historically. In Scotland we will base significant hubs in Edinburgh and Glasgow and one or two others in other parts of Scotland, where there will be telephone centre activities, for example. That is the type of logic that goes into how we will arrange and morph our business into the future.

I have a question about the historical situation. You give the impression that what happened in autumn last year was part of a general worldwide recession and had come somewhat out of the blue. However, if you look back at the Financial Times's coverage of things such as the growth of instrumentalised work gauges and the like, it reports that from about the middle of 2007, when Moody's reassessed its super-standard investments, a general freeze started in France and set into international financial markets. When Sir Victor Blank went to HBOS in autumn 2008 and a deal was rapidly done, as you said at the beginning of your remarks, were people then fully apprised of the nature of the debt problem in HBOS, to which you alluded in relation to the corporate investment area? Even the Financial Times was backing the stand-alone survival of HBOS for about a fortnight after that. When did the real problems of HBOS become apparent to Sir Victor Blank and the Prime Minister?

I will not speak for Victor Blank or for the Prime Minister; it would not be appropriate for me to put words in their mouths. However, if you cast your mind back to autumn 2008, you will remember that things were extremely tense and there is no doubt that there was a global situation. One of the key moments in the UK was the failure of Northern Rock. The other big event in the global environment was the failure of Lehman Brothers. Subsequently, a whole series of banks got into trouble—UBS was a classic. We have since ended up with a raft of different banks including Fortis, Dexia and ING getting into trouble.

The big issue that impacted on all banks at the time was the possibility, along with the withdrawal of credit and funding in the interbank market, of panic in the retail banking market. We all remember the photographs of the queues outside Northern Rock branches. I believe that the authorities were right to be concerned about that possibility, and I believe that they took the necessary steps to prevent the spread of that contagion. Had it continued and developed, it would have had a considerable impact on us all and, to be frank, I think that our discussion this morning would have been very different. The widespread impact of a severe failure in the banking system, which leads to a lack of confidence among the population at large, is dire for an economy such as ours—or, indeed, for any developed western capitalist economy—and the steps that the various Governments have taken have proved to be absolutely right.

By the time we, as a board, reached the decisions on HBOS, we knew that the bank was having real funding difficulties, as Mervyn King made clear in his comments to the Treasury Committee last week. These things are all well understood.

Can you put a figure, to the nearest billion, on the bad-debt problems in HBOS's corporate division? I have heard that it is north of £70 billion.

I can refer you only to what is in the public domain and our published accounts—I am not allowed to go any further than that. We have articulated the provisions that we have made and have indicated the rough percentages of those provisions, with HBOS accounting for about 80 per cent of impairments. As for the £260 billion of potential impaired assets that we would have put into the asset protection scheme back in March if we had proceeded with it, the percentages are very similar. That gives you a rough idea of the situation but, as I say, I cannot really talk about anything that is not published or in the public domain.

Would a so-called bad-bank facility into which these assets could have been placed have assisted you by simply taking them right out of your hands?

I think that that is what the Government had in mind when it devised the asset protection scheme, which was more of an insurance scheme. The point is that if there is going to be a bad bank, someone has to fund it; the insurance element of an asset protection scheme has the same impact. As a result, the two concepts are kind of related.

Do you not think in some sense that the major problem of the companies into which HBOS bought at the height of the housing boom—even then, it was evident that nemesis was on its way—has retarded the prospect of offering bank services to local businesses and small and medium-sized enterprises? If you have on one side Crest Nicholson, McCarthy & Stone and Kenmore with their billions of pounds of debt and, on the other, relatively small concerns simply wanting some cash to tide them through, surely you are faced with a rather difficult juggling act.

It certainly was a difficult juggling act for HBOS. Because of issues such as that to which Christopher Harvie refers, HBOS was basically running out of funds. That would have impacted right across all the HBOS businesses. The lack of funds—lack of liquidity—eventually impacts on a bank's capital and on its ability to raise and access capital. That was definitely the case for HBOS, but we are not in that situation now. Our rights issue has received huge support, which puts our capital in a very strong position, and we have improved our access to liquidity every month this year as we have gone on. So, we are improving. I am not saying that we are yet in the position that we would like to be in; however, the Lloyds Banking Group is going from strength to strength.

The rights issue demonstrates the public investor view of the organisation. It means that we are able to provide banking and financial services to all our clients, be they retail businesses, small businesses or start-up businesses. We intend to finance some 300,000 start-up businesses over the next two or three years throughout the UK. We have serious intentions in the start-up and SME space, and we are focused on that. We realise its importance for the UK as a whole and for Scotland—the percentage of gross domestic product that is generated by small to medium-sized enterprises in this country is now significant. It is in all our interests, including our group's interests, to be actively engaged in fostering and promoting that sector of our economy.

I have spent 30 years teaching—partly economics—in Germany, where the local banking system is to a great extent mutualised. You have a tradition of mutualisation within Lloyds HBOS, through the TSB and the Halifax Building Society.

Let us say that there is a double-dip recession, meaning that a lot of our more optimistic ideas might be scattered. Would not it be precautionary to explore the notion of having a more mutualised structure in keeping with the practical mutualisation of a lot of the activities that are being spun off from new communications techniques—the Google revolution? Would not it be better, as far as your local banking and investment networks are concerned, to revert to something that is closer to the Kreissparkasse model or the old-fashioned mutual building society model for some of your activities?

There is no doubt that mutuality has a role to play. There are some very fine mutual organisations operating within the UK. I am also aware of the German banking model. We have a good and healthy insurance company in Germany and I was there for two days last week, so I am aware of how the financial system operates in Germany. The only thing that I would say is that any period of financial difficulty impacts on mutual organisations as well as on private organisations, and in the UK a number of mutuals have been in difficulty and have had to be rescued and taken over. I would counsel that mutuality, in and of itself, is not a solution to the sort of crisis that we have been through. Nevertheless, I believe that mutuality has a useful and vibrant role to play.

In your written submission, you state:

"We believe that we have a social as well as an economic role in Scotland and we take it very seriously."

In the light of that, can you tell us why Lloyds Banking Group is refusing to consider proposals by the Lloyds TSB Foundation for Scotland regarding its future?

We take our social responsibility seriously. We are part of the community wherever we operate and must be cognisant of that.

I will explain briefly how the foundations operate. We have four foundations: a Scotland foundation, an England and Wales foundation, a Channel Islands foundation and an Ireland foundation. All those foundations have exactly the same covenant and the same memorandum and articles—they have the same arrangements with the group. They are funded by the group, and the funding is 1 per cent of the average of the past three years' profits. However, we are no longer making profits. If we continue as we are, there will be no money available to any of the foundations—not just the Scotland foundation, because the position is exactly the same for all of them.

We must recognise the difficult economic reality of the situation that we are in; nevertheless, we want to support the foundations. We have had negotiations with the foundations in order to come up with a solution to the problem. Those discussions have been led at very senior level within the group by Lord Sandy Leitch, who is a Scot and understands the Scottish situation extremely well. He has led the negotiations with the foundations. Unfortunately, only three of the foundations have engaged in the discussions—the Scottish foundation has not. We have yet to come to a final resolution with the other three, but the negotiations are well advanced and we are hopeful that we can come up with a solution to the short-term problems in financing the foundations.

I will explain what happens if we do not come up with a solution. For the period during which we are in a loss-making situation, we will pay £200,000 to the four foundations, which will be split in different proportions across the foundations. That is how the covenant currently works. We are trying to find a way to fund the foundations through the difficult period. In order to do that, we must take all our stakeholder groups into consideration—we cannot give advantage to one stakeholder group over another. We have customers, employees, investors, the foundations and the charities. Sandy Leitch is trying to find a way to fund the foundations through a difficult period while rebalancing the whole way forward for the foundations, which is why we are having the discussions.

Let me try to unpick some of that. Can you confirm that the covenant was set up in perpetuity and has been in place since 1985? Can you also confirm that, unless it is broken by the group, it will run for at least the next 25 years?

No—that is not correct. The covenant was set up in 1985 or 1986, at the time of the TSB's demutualisation. However, the covenant can be dissolved when one of three conditions is met. If the Lloyds Banking Group was taken over, or was to become insolvent, the covenant would continue to run for one year, and if the Lloyds Banking Group gave notice to the foundations, the covenant would continue to run for a nine-year period. The position is the same for all the foundations.

My point is that the first two of those three conditions do not apply. The third condition requires the covenant to be broken by the group. If that does not happen, the covenant will continue to run for 25 years.

Wendy Alexander is right, unless we can find a resolution that is consistent for all the foundations—we must treat them all exactly the same.

Let us come to the question whether you are obliged to treat all the foundations comparably. Am I right that the essence of the group's proposal is to reduce the foundations' funding from 1 per cent to 0.5 per cent of the group's pre-tax profits?

A package of proposals has been put to the foundations, part of which is a reduction in their funding from 1 per cent of the group's profits. When the foundation was set up, it was the TSB Foundation and, up to now, some £85 million has been disbursed through the Scottish foundation. However, since Lloyds got together with the TSB Foundation the cake has got bigger, so the proposal is for the foundations to get a smaller slice of what is now a much larger cake.

Over time, the amount of funding that the foundations get should increase, but we must balance all our stakeholder groups. We must take into consideration our investors, our employees, our customers and all our stakeholder groups. We cannot consider one stakeholder group—in this case, the foundations—in isolation. We must take into consideration the economic reality of where we are. At the moment, we are not making profits. If we continue with the covenant as it stands, the foundations will not have any money.

As you know, provision is made for what happens when the group is not making profits. No one doubts the need for short-term transitional arrangements, but I am pressing you on why the essence of your proposal is to halve the amount of money that goes to the foundations when the group is profitable. Why is that the right thing to do?

Because we have to balance all our stakeholder groups. We cannot look at the position of the foundations in isolation.

Which stakeholders have you consulted on the proposal to halve the amount of money that goes to your charitable foundations?

The board considers all its stakeholder groups consistently. That is part of its remit.

The obvious stakeholder to ask about is UK Financial Investments. Have you consulted UKFI or the Treasury on the proposal? Given that UKFI owns 43 per cent of Lloyds, it would seem the obvious stakeholder to start with. Has it sought the proposed reduction? Has it been consulted in any way?

Clearly, UKFI has not sought any reduction. I am not involved in the discussions that take place, which are led by the deputy chairman of the group—you can take it from the fact that the issue is dealt with at such a senior level that a great deal of importance is attached to it.

The fact of the matter is that we are in an economic situation in which we are not making profits. If we continue with the covenant as it stands, the foundations will not get any money—or rather, they will get £200,000, as opposed to the millions of pounds that they got in the past. If we do nothing and just carry on, as you suggest, the four foundations will end up with £200,000, which will be split among them in different proportions. In an effort to solve that problem, we have come up with a proposal for funding the foundations through the difficult period, which involves rebalancing our stakeholder interests.

No one disputes the need for transitional arrangements for when you are not making profits. We have dwelt on the scale of public support that has been made available to you. I am asking you to justify why it is right to halve the share of profits that you make available to the foundations when you are profitable. Has any stakeholder prevailed on you to do that?

It was not originally envisaged that the covenant would apply to a group as large as Lloyds Banking Group, which comprises HBOS and Lloyds TSB. There is no doubt that the foundations will get a smaller slice, but the cake will be much larger, so the quantum that they will eventually be paid will be larger—they will get more pounds. We have had highly productive discussions with three of the foundations; one foundation has chosen to take a different stance.

I put it to you that you cannot provide evidence that the total amount of money that will go to Scottish charities will increase, given that, for example, the HBOS Foundation has been closed. Can you provide any evidence that the total amount of money that will be available to Scottish charities will increase as a result of halving the share of profits to which they are entitled?

Clearly, we cannot give profit forecasts, which is what you are asking me to do. You know that, legally, I am not allowed to give a profit forecast, so I cannot do that.

You have said that the basis of your decision is that more money will be available to Scottish charities, but I simply do not see how you can sustain that with evidence because, as you say, to do so would involve forecasting profits. I am asking you to provide a justification for halving the amount of pre-tax profits that will go to Scottish charities when the group is profitable; we have not had such a justification. I am asking you to name any stakeholder that has urged that action on you.

As I said, we have engaged in negotiations with the four foundations. Three sets of negotiations are progressing actively, but one is not. The door is still open. We would still like to fund all the foundations through the difficult times, and I would like us to fund the Scottish foundation through difficult times. However, our approach to all the foundations must be consistent—treating one foundation differently from another would be totally inappropriate.

I will pursue that in the context of Lloyds TSB Scotland's different history. The Government has a 43 per cent shareholding in Lloyds Banking Group. We in the United Kingdom have recently had active discussions about the financing of the devolved Administrations. It would be extraordinary for Jim Murphy to walk into a Cabinet meeting and say, "I'm prepared to consider only exactly equitable arrangements for Northern Ireland, Wales and Scotland," so I am slightly puzzled as to why you—the Scottish member of Lloyds Banking Group's board—do not seek to facilitate a solution to the problem in Scotland. I presume that that is in your power to achieve, should you choose to do so.

I ask you to take a step back and think about where the money is coming from—Lloyds Banking Group. The Lloyds TSB Foundation for Scotland receives a disproportionately large amount in comparison with the size of the communities in which it operates. That was agreed when the covenant was drawn up, and we are not talking about changing any of that. However, it would be inappropriate for us to treat the foundation in Scotland differently from those elsewhere, given the number of people whom we employ, our large number of customers and our involvement in society in those other areas. I admit that I disagree with you—it would be inappropriate to treat one foundation differently from another. If the situation were reversed, I would make the same argument in relation to the other foundations.

You are prepared to carry the reputational risk to Lloyds Banking Group in all parts of the UK—although the organisation has benefited in the past 12 to 14 months from more than £20 billion of Government support—of not being prepared to consider maintaining the arrangements for supporting charitable organisations throughout the UK that support some of our most vulnerable groups. Is that not a reputational risk that requires revisiting?

We are absolutely keen to support the foundations through difficult times, and we have made a proposal to help to do that.

Will you give an undertaking today that you will consider the proposal that the Lloyds TSB Foundation for Scotland has put on the table? We simply ask for that to be considered.

Through Lord Leitch's good offices, we are actively engaged in negotiations with all the foundations. We will continue to negotiate—the door is open and we will continue to have dialogue. I would love to see a solution that includes all the foundations, and I undertake that we will continue to discuss the situation with them and to negotiate. We seek a solution whereby we can support the foundations with significant sums through difficult times.

We need to check your views on a couple of matters for the record. What are Lloyds Banking Group's views on the divestments that the European Commission proposes?

Deep and significant negotiations took place with Brussels about the businesses that we must dispose of. As I said, we have ended up with a portfolio of businesses to divest that consists of the Cheltenham & Gloucester, Intelligent Finance, Lloyds TSB Scotland and a range of branches throughout England and Wales.

It is painful to have to divest those businesses, but, given what has happened to a range of banks that have gone through the same process with Brussels, we regard that as probably a reasonable and fair outcome. We do not see that process as having a significant negative impact on the development and implementation of our strategy in future.

Let me move on from that. Is there a timescale for the selling off of the Government's shares in Lloyds Banking Group? Do you have any particular views on how that process should take place?

We do not decide when the Government sells its shares. That is entirely within the hands of the Government, which has appointed UKFI to hold those shares. Our understanding—I think that this is public—is that UKFI will seek to get money back for the taxpayer and that it hopes to make a profit in the process. The decision is within the hands of UKFI as the agent for the Government.

If there were further pressures on Lloyds Banking Group to raise more cash, would it consider selling off some of its existing businesses, such as the Bank of Scotland, as a means of raising cash?

Sorry, can you say that again?

If Lloyds Banking Group needed to raise further cash after the current rights issue, would it consider the option of selling off parts of its existing business?

We have absolutely no intention of doing that. We have embarked on a rights issue, which will create an extremely strong capital base and has been well supported. It is not our intention to dispose of any parts of the group. Of course, all groups are living organisms that acquire and dispose of different parts as time goes by, but we have no plans to do such a thing.

My final question is on the various proposals that have been made about regulation and corporate governance. What is Lloyds Banking Group's view on regulatory change and corporate governance? How well placed are the group's existing corporate governance arrangements to meet the potential requirements of, for example, the Walker review?

We fully intend to comply with the Walker review, and we have signed up to the Financial Services Authority's recommendations on remuneration as well as to the G20 recommendations. We are very comfortable about complying with all those recommendations.

We are a strong supporter of a firm and robust regulatory environment, and we hope that regulation will change for the good. We would like to see consistent and robust regulation—not constantly changing regulation—and we are a firm supporter of strong regulation. We intend to play a role within the regulatory framework.

Will any of the proposed changes to regulation threaten the group's ability to carry out business in the international market?

The big issue is consistency of regulation from jurisdiction to jurisdiction. If there is inconsistency of regulation from one geography to another, that can create disequilibrium and advantage one territory over another. That is a significant worry. For example, if country A has an extremely draconian regulatory environment by comparison with country B, capital might flow from country A to country B. Capital can flow in minutes, as it is unbelievably liquid. If the regulatory environment becomes too draconian, the second thing that will flow is skills, which are the next most liquid resource. Therefore, the regulatory issue is about having not just a strong and robust regulatory environment but consistency in the global environment. Moving ahead such that we get out of equilibrium with other jurisdictions could create problems.

I thank Archie Kane for coming along today to give us his very robust answers to our questions. That has been very helpful indeed. Our next session on the banking inquiry will be next week, when we will hear from HSBC's chief executive for Scotland and from the Financial Services Authority.

I suspend the meeting for a few minutes while we change witness panels.

Meeting suspended.

On resuming—