Financial Services Inquiry
The next item of business is our banking and financial services inquiry. This is the third of the three scene-setting sessions that we agreed to have at the start of our inquiry to enable us to understand the main issues better before we take detailed evidence from November onwards.
There is probably no one who personifies the banking crisis more than our next witness, Robert Peston, the BBC's business editor. The committee welcomes the opportunity to hear his perspective on the causes of the crisis, the challenges that we face and the future regulation of the financial sector. I invite him to make some opening remarks, after which we will ask questions.
Thank you for inviting me to talk to you about this. There are few issues that are more important in the world than the need to draw the right lessons from the economic and financial crisis that we have experienced recently. One of my slight fears has been that issues to do with, for example, the structure of the banking industry are normally regarded as dull stuff for professional economists and what one thinks of as the financial priesthood—the regulators and the central bankers—rather than stuff that will make the front pages of popular newspapers or be seen enough of in the broadcast media. My view is that this stuff matters to all of us. In the past, we trusted the financial priests rather too much to get it right and they patently did not get it right. It seems to me that, before we draw the conclusion that we are somehow over the worst and that we can tolerate a patching-up of the status quo, a proper national debate is required, so the fact that the committee is considering the issues in such detail is fantastic.
The focus of the inquiry is largely on looking ahead at where the sector needs to go, at how we can protect jobs in the financial sector in Scotland and at how competition issues can be dealt with. The Scottish Parliament does not deal with the regulation, but any changes to the regulation of the financial sector will have an impact in Scotland. Where do you see the banking sector, particularly in Scotland, going over the next year, two years or three years?
The banking sector in Scotland cannot be divorced from banking globally, as banking is now one of the more globalised industries. There are issues that are particularly pertinent to Scotland, to which I am sure we will return, but one needs to start with the broader question of where banking in general is going. There are some obvious and simple points to make. One is that, for as far ahead as one can see, some of what the banks did wrong over the previous few years will be corrected. They are lending less relative to their capital resources, mostly as a result of being forced to do so by regulators and Governments, but partly as a result of having woken up and smelled the coffee. In other words, banks globally are managing themselves slightly more prudently. They have woken up to the notion that liquidity matters and that they need to take seriously the quality of assets that are available for sale. They have realised that, in simple terms, they can no longer ignore, as they did previously, the amount of cash that they have available to meet demands.
I am sure that members will know that one great criticism of banks in the preceding few years was that they were reasonably focused on the asset side of the balance sheet and the quality of the loans that they made but hopeless at managing the liability side of the balance sheet, which is about where the money was coming from. Among the many striking statistics that show what went wrong is that, for the Royal Bank of Scotland and, in particular, Lloyds, because of its purchase of HBOS, the ratio of their loans to customer deposits was well over 150 per cent, which was a manifestation of how dependent they had become on wholesale markets. They treated the wholesale markets as permanent sources of funding that could not possibly dry up but, as we know, in the summer of 2007, that turned out to be an utterly misplaced and reckless assumption. They are now in the process of managing down their exposure to wholesale markets. They can do that thanks only to the munificence of all of us taxpayers. When the wholesale markets dried up, we had no alternative—we had to bail them out by lending to them directly or they would have gone bust.
A statistic that I regard as one of the defining characteristics of the crisis is that, through loans, guarantees, investments and the creation of new money in Europe and the US, taxpayer support for banks is, at the last count, $15 trillion, which is more than $2,000 for every person on the planet. In the United Kingdom, we have provided about £1.3 trillion of support. Barely a bank would be alive today without that support, much of which was in the form of funding. The issues that will define much of what happens in the next few years are how the banks correct their excessive reliance on the wholesale markets and how we as taxpayers manage down our support for the banks. Plainly, for the long term, it does not sound like a good idea for us to support the banking system indefinitely to the tune of $15 trillion. However, how we withdraw that support in a way that does not put enormous pressure on banks, at a vulnerable time, to stop lending or to reduce the amount that they lend is a tricky issue. We therefore face massive challenges.
It is a little early to make cast-iron predictions about the future structure of the banking industry, partly because there is still a debate in train about whether it makes sense to break up the banks, for example. Breaking up the banks raises two issues. The first is competition, which Neelie Kroes is looking into. The second is whether the banks have become dangerously large relative to the size of their respective economies, putting them in a position of always holding taxpayers to ransom, and whether their mix of businesses—the notorious conjoining of the so-called casino of investment banking with retail banking—is a dangerous combination. We are only at the beginning of the debate on whether the so-called universal banks, such as the Royal Bank of Scotland, Barclays, UBS of Switzerland and Citigroup, are, in a sense, intrinsically weapons of mass destruction.
Thank you. You have answered my next question. It is often said that the banks became too big to be allowed to fail. Is that what happened? Should we now break up the banks so that failure is a possibility for them and they are a bit more conservative in their management to ensure that they do not fail?
It is plainly crazy that the banks want to be left alone to compete in the market, to look for business and to generate profits, yet they are permanently in receipt of 100 per cent insurance from taxpayers, as we have found out. Unlike in other sectors of the economy, when it came to it, we could not take the risk of allowing any of the banks to fail. Common sense dictates that if someone is allowed to go out and do what he or she likes to make profits, when he or she gets it wrong he or she should pay the price. Plainly, those institutions did not pay the normal price of failure because, if they had failed, the cost to all of us would have been immense in terms of the damage to the economy.
None of us can escape the conclusion that the status quo was completely unacceptable, partly because of the size of the institutions. When the Royal Bank of Scotland got to the stage at which its balance sheet was greater than £2 trillion—which is a significantly bigger amount than the value of everything that we produce in this country—it was unthinkable that it should be allowed to fail, given the repercussions for the availability of credit, for moving money round the economy and all the rest of it. If a bank of that scale had been allowed to fail, the recession would have become a depression.
The tricky question to answer is whether the problem was the size of the institutions, the combination of their activities or a bit of both. If it was both their size and the fact that some of their activities that were vital to the functioning of the economy—taking deposits and lending to small and medium-sized enterprises and other businesses that could not be allowed to collapse because of the damage that that would do to all of us—were conjoined to the more speculative activities of the investment bank, two separate questions arise. First, how can we limit the size of the banks? Secondly, is it conceivable that we could put in place arrangements whereby there would be an internal separation between the so-called casino and what one might call the utility bank—the bit that matters to us? That is something that the Bank of England and the Financial Services Authority are currently working on. The authorities in London are working on what are termed living wills. That is code for putting the different activities into wholly separate legal structures and trying to ensure that there is little overlap or contagion between the two, so that, if the bank were to fail, the bit that matters could be lifted out and saved, and the bit that we regard as less vital to the functioning of the economy could be left to take its chances and, in effect, to fail.
At this stage, it is unclear to me whether the ambition of making these conglomerates—the universal banks—safe without breaking them up can succeed. Distinguishing between the two parts of banks is tricky. Banking is complex, and there would have to be a lot of regulatory intrusion all the time to ensure that the two—or more—bits of a bank were being kept separate. There is a commonsense argument that, if we think that for public policy reasons the two types of activities need to be kept separate in a legal sense within one organisation, it might make life simpler for everyone if we broke up the organisation, so that the activities were not connected in any way. Arguably, that would make life a lot easier for regulators.
The solutions that we are seeking at the moment tend to put an enormous emphasis on the quality of regulators. Basically, we are saying that we want much better regulation and regulators. There is no doubt in my mind that the FSA's game has improved. The FSA has admitted that it did a lamentable job in the previous few years. My impression is that things have improved, but would it not be better for us to be less reliant on the human frailty of regulators by having an institutional structure for banks that was intrinsically less dangerous?
Do you agree that there was a regulatory failure in the system? If so, was it limited to management of the UK-based banks, or was there a worldwide failure to regulate some of the financial instruments that are one of the causes of the problem?
Do we have another couple of days to talk about the issue? An extraordinary amount went wrong. When we look back at the preceding few years, it is astonishing how much went wrong. As you know, part of the background to the crisis consists of what are known as great global imbalances. There was an excess of saving in places such as China and Japan, which was recycled, in effect, into cheap credit in the UK, the US and other parts of the west. Many economists, politicians and central bankers said for years that that was unsustainable, but we went on and on accumulating debt in the UK and the US and accumulating surpluses in many other parts of the world—the middle east, China and Japan. The problem was not and has not yet been fixed. There is no doubt that it created instability and was a big contributor to the crisis that we experienced.
There were two kinds of regulatory failure, one of which was broadly lethal for the global economy and one of which was unfortunate. The unfortunate stuff stemmed from the fact that the supervision of individual banks was not good enough. The FSA has acknowledged as much; it has admitted that it did not boss the likes of HBOS, Northern Rock and the RBS around enough when they were doing reckless things. Northern Rock should not have been allowed to have become so incredibly dependent on wholesale markets, because that made it a very risky bank, and it should almost certainly not have been allowed to lend all those billions in the form of 100 per cent plus mortgages or, indeed, the 95 per cent mortgage and personal loan package that meant that it was lending up to 125 per cent of a property's value. That sort of bonkers behaviour would have had any sensible regulator saying, "Hang on a second—this does not sound like prudent banking." It is also amazing that HBOS was allowed to become so extraordinarily focused on particular sectors and that regulators simply did not stop all its corporate lending to property and construction.
My own view is that inadequate supervision has been costly to us all because it caused problems at individual banks to be worse than they would otherwise have been. The massive systemic failure, however, was to allow almost all banks to lend far too much relative to their capital requirements and to become far too dependent on wholesale finance and lend far more than was altogether prudent relative to their deposit bases. That failure happened in the UK and the US and was induced by too many years of things going well and people failing, for a whole variety of reasons, to measure risk in a sensible way.
The failure was also a result of the Basel I and Basel II accords, which set global standards for banks' capital and liquidity requirements but also encouraged banks to game the system and do all sorts of silly things to get round the rules. They were an attempt to micromanage banks but, on the whole, banks are smarter than regulators and were able to get round the rules to an horrific extent. Of course, it turned out that they were not as smart as they thought they were. I will not go on more about this now—you might want to ask questions about it later—but I think that the global rules were part of the problem, and they certainly need fixing.
I am tempted to draw lessons here.
With regard to the regulatory failures that you mentioned, do you think that the system of regulation that the UK Government has now put in place will effectively tackle the current problem? The corresponding question, of course, is whether the various elements of the original tripartite system that Gordon Brown set up actually talked to one another and whether any regulatory activity could have been carried out under it that might have helped us to avoid the current situation.
You will have to forgive me but, as I work for the BBC and am supposed to remain politically neutral, I will not be able to answer one part of your question directly.
However, you have hit the nail on the head. What matters is that the central bank talks to the regulator and the Treasury and that relevant information is shared. Plainly, for a period, part of what was going wrong was that the different bits of the tripartite system were operating too much in their own silos. As a result, the right kind of market intelligence was not being shared across the piece. It may also have led to a more cumbersome approach to the bank rescues initially, although the shock has meant that the three authorities have been working together much better more recently.
It plainly matters that central bankers talk a lot to supervisors if they are to understand what is going on. In good times and bad, there is a tremendous connection between ensuring that banks have the right amount of capital and the sort of stuff that the Bank of England is interested in, such as credit conditions. One thing that went wrong over a period of years was the complete disconnect between monetary policy, which is the Bank of England's role in ensuring sufficient liquidity in the economy, and prudential supervision. The two are inextricably connected, yet the two parts of the system operated as though there was no connection. For example—to tell you stuff that I am sure you know—if a bank is required to hold X per cent of its loans and investments in the form of regulatory capital, that requirement has a significant impact on its ability to lend and, therefore, on credit conditions in the wider economy. However, those decisions on capital adequacy were taken completely separately from the Bank of England's decisions about monetary conditions in the economy, such as whether interest rates should rise or fall and all the rest of it. Plainly—just as a definitional point—quite apart from what led to the crisis, the fact that those two activities were so separate was not a good thing. When people talk about the need for macro-prudential supervision, they are in part capturing that need to bring those two functions rather closer together.
Another point is simply that the lender of last resort, which must be the central bank, cannot operate independently from the organisation—in this case, the FSA—that, in theory, oversees what goes on in the market. It is plain that the two organisations were too disconnected. They have acknowledged that they need to work much better together.
It is for others to decide whether the appropriate partnership can be forged by keeping that separation between banking supervision and monetary policy, as is the Labour Government's policy, or whether the Conservative party is correct that it would make sense to transfer banking supervision to the Bank of England. What matters is not the institutional arrangements in a theological sense but what works.
Given that the Bank of England is currently arguing for more powers and given its debate with the FSA on the structure of banks, will the forthcoming banking bill—which your blog describes as a short bill "of perhaps 50 clauses", according to your sources—lead to root-and-branch change, or will it just tweak the system in the hope that things will get better?
Are you talking about the regulatory system or the tripartite system?
I am talking about the tripartite system.
The Government's position is that it believes that the tripartite system can be fixed. The Government intends to give new powers to the FSA and is trying to create a framework in which the Bank of England and the FSA work more closely together.
I will be honest with you. I think that there are risks on both sides. The risk of doing what the Tories want to do and transferring banking supervision to the Bank of England is that it would create an enormous institution. The Bank of England would be the most powerful non-elected institution in the country by a mile, and also a huge and complex institution. There would be a management challenge and also a democratic accountability challenge. One should be under no illusion about what would be created in those circumstances. In many ways, the Bank of England would be much more powerful than the London Treasury because it would have absolute control over all aspects of macro policy other than fiscal policy, and even then it would have some indirect influence on fiscal policy. There are democratic questions about whether that is the right direction to take, and there are questions about whether it would be manageable.
On the other side, if banking supervision is not transferred to the Bank of England, is it possible to put in place a genuine partnership approach? If we look around the world, there is no perfect model. Every country, more or less, is agonising about those things. Although one or two countries have come through the banking crisis better than others—Canada and Australia have come through it all right—they have different regulatory models. We cannot say that their experience tells us that there is an optimum structure. As always, these things are to do with history and culture.
In the end, we have to consider the need not to make the system too cumbersome—some would say that the tripartite system was a bit cumbersome—versus the democratic and management issues that will arise if banking supervision is moved across. It is definitely a tricky one.
You say that although the tripartite system is cumbersome, it has benefits for the country. We are thinking about our banks and the need for finance. Do you think that the proposals for banking reform that are to be discussed in the House of Commons and the House of Lords in the next six months will effectively deal with the problems that have occurred and create a playing field that is much clearer in future?
Sorry, I am being a bit thick. What do you mean by that?
Will the short bill just tweak at the edges or will there be root-and-branch reform that makes it clear where discussions take place between the FSA, the Bank of England, the Treasury and so on. Will we be able to see a lot more transparency of regulation?
It is plainly not simply a question of tweaking, but one should not forget that since the crisis there has already been one quite big regulatory change: the Bank of England has been given the power to take over a failed bank. Indeed, it has now exercised that power. That is plainly an important step in the right direction. When the crisis with Northern Rock blew up, it was impossible—or very difficult, anyway—to put it into an administrative procedure that would not have caused significant harm to depositors. That was a terrible failing of the previous regulatory system. The fact that the Bank of England now has the ability to take over a failed bank's assets speedily in a crisis, which allows the deposits to be hived off and kept whole, is an important step in the right direction. Many would say that it was long overdue.
When it comes to the systemic issues, it is not 100 per cent clear to me who is in charge, or rather, who will be in charge when the bill becomes law. It is unsatisfactory that, at the moment, the systemic issue falls between the Bank of England and the FSA. There must be oversight of the system as a whole. When excessive risks are being taken, it is hugely important that that is monitored and that judgments are made and acted on. However, it is unclear to me whether, after the legislation has been passed, we will be clear enough about precisely where the buck stops.
The FSA and the Bank of England are trying to forge a partnership. John McFall MP, who is a member of a committee that you might regard as a competitor—
No, no. It is complementary.
John McFall asked the right question when he wanted to know who would get sacked when it all went wrong. That is a useful question to ask of any organisation in which there are proper lines of accountability. It is not 100 per cent clear to me who would get sacked in those circumstances, which may be a problem.
Who should have been sacked the last time that it went wrong?
A few bankers lost their jobs, but it is a weird thing. We have had a crisis the like of which we have never seen, yet because there were so many causes and because so much went wrong, more or less everybody was able to say, "It's partly my fault but it's also everybody else's fault, so I don't have to fall on my sword." Many people out there regard that as unsatisfactory.
The original coverage of the crisis is interesting. Although our remit is to look forward, it is useful to learn from past developments. When Alistair Darling told The Guardian that he foresaw a financial and economic threat to the global economy such as we had not seen since the 1930s, many commentators were sharply critical. I recall that you were one of those who said that he was perhaps right. What were the first danger signals and how well were they picked up and acted on in the early part of the crisis?
There were two phases. The first was the creation of the bubble in the period before the summer of 2007. The awful truth is that, although many people such as I saw bits of what was going wrong, very few—I would argue almost nobody—saw quite the scale of the bubble that had been created. The lesson that we have learned is that we must somehow devise a system in which it is possible to view the financial system with slightly more acuity than we could before.
There were lots of warning signs that lots of people picked up in different ways. You will all remember the concerns that were widely raised about the fact that British households were borrowing far too much. It was no great secret that the indebtedness of households rose to more than 170 per cent of their disposable income—an all-time record by a mile. That was visible. Also, although it rarely got off the pages of specialist publications or outside the last page of the Financial Times, the $60 trillion notional size of the credit derivatives market—which turned out to be something of a problem—was well known within the central banking regulatory world, yet its explosive growth was simply allowed to continue. In fact, far from trying to limit that growth, people such as Alan Greenspan were on the record as saying that those innovations were good things.
A number of things happened. In 2006-07, it was perfectly clear to me that banks were reducing the normal standards that they applied when lending. There was a range of banks lending as if there were no tomorrow and reducing the stipulations for security that they normally ask for. You have probably come across the notorious covenant light—or cov-lite—loans in relation to leveraged buyouts or private equity, whereby banks lent colossal sums with no strings attached. That was plainly a warning sign that banks were out of control. There was a period of euphoria in which their judgment was plainly undermined by the massive profits that they were making and bonuses that were being given. Plainly, that was a warning sign.
There is also the issue of the sheer complexity of the instruments. The moment that I knew that there was a big problem came when I did a little piece for the "Today" programme in spring 2007, which was before markets froze up. I felt like torturing 5 million or so "Today" programme listeners, so I thought that I would get senior bankers to explain credit derivatives and collateralised debt obligations. I put a microphone in the face of a senior banker at Morgan Stanley and said, "Pretend you're talking to your grandmother and tell me what collateralised debt obligation is." A quarter of an hour later the sweat was pouring off him and it was plain that his grandmother would be able to understand what this chap did for a living, but only if she happened to be a hedge fund manager.
The serious point about that is that, if an individual who does that cannot explain it in language that we can understand, it makes me worried that he does not know what he is doing. Further, as you will all know, the people at the top of those organisations did not understand what those highly paid employees were up to either. The way the system worked was that they employed risk managers, who employed other risk managers who talked to the traders and collated and processed the information in a way that could be fed up to the top board. At the end of the day, the board got what you might call a sanitised version of what was going on, which did not give them a handle on the risks that were being taken. That was plainly a disaster.
There were all sorts of warning signs in the run-up to the 2007 meltdown, and there was of course a second phase. You referred earlier to the remarks that Alistair Darling made. That was in summer 2008, which was a full year after the extraordinary shock to the financial markets. There were two periods of delusion. There was a period of delusion in the run-up to summer 2007, when we effectively ignored all the debt and the leverage that had built up into an unsustainable bubble, and there was a period in the year after summer 2007, when most of the authorities failed to appreciate the significance of the credit crunch and the economic harm that was being done by the massive contraction in credit that had been caused by the freezing up of the markets in that summer. The collapse of Lehman Brothers was a totemic event. At that moment, the world woke up to the fact that we faced a major crisis. However, to be frank, that was only a wake-up call—the crisis had already arrived. All Governments, regulators and central bankers failed to understand the significance of what had been going on.
Once an understanding of that became clearer, was it communicated effectively? In other words, were people in your position and in the sectors themselves too slow to report and make the situation transparent to the wider public?
Again, there were two phases. The media in general was pretty lousy at calling time on the bubble before the summer of 2007. Let us be clear. In some sense almost everyone was implicated in the bubble, whether it was people buying a house at the top of the market with a 100 per cent mortgage, or the Chancellor of the Exchequer loving all that tax revenue that was coming from the city and not looking under the bonnet at what the city was actually up to, or the newspaper groups getting lots of lovely advertising from estate agents and property supplements or television companies getting lots of lovely viewers for programmes telling them to go out and buy another house to do up. I am afraid that, as a society, we were all implicated in the bubble. My view is that the record of newspapers and television was marginally better in warning of some of the risks than the central bankers and finance ministers were but, as I said before, that is just saying that we were myopic rather than blind, not that we have a distinguished record. However, after the summer of 2007 the media captured more of the scale of what was going wrong and needed to be fixed than was true of the authorities.
It can be either feast or famine with the media. Another criticism that has been made of the media is that, when a sector depends on confidence, as finance does, the reporting of one collapse can promote another. Is there any truth in that?
What Keynes calls "animal spirits"—confidence—is incredibly important, and the media have to think about that. However, we also have to think about our role in the good times as well as in the bad times. You could criticise the media as much for making people less aware than they should be about the risks of taking on debt. Maybe we should have been less complicit in saying that the rise in house prices was all for the best in the best of all possible worlds.
To say that it is better for the media to underwrite a bubble than to prick it is a slightly odd way of looking at things. We have to provide solid, neutral and impartial views through good times and bad. Obviously I have had to think long and hard about this because people have periodically accused me of damaging individual institutions or the economy. In the autumn of 2007, I got a huge amount of criticism, so I am acutely aware of the journalist's responsibility to stick to the facts, not to put them in an alarmist context, not to speculate, and not to be sensational. It is terribly important that one provides balanced reporting.
I also take the view, however, that we have a public duty to tell it as it is. What to me is just straightforward news that people have to have is, to some people, horrible news that they would rather was not out there. I am afraid that, in the end, I and the BBC have to make a judgment about what the public has a right to know. Although I do not say that the confidence issue is trivial—it is important—what matters most is that the media should provide the information that people deserve, whether the news is good or bad. That is a particular challenge for us.
It is almost impossible—in fact, I would say that it is impossible—to prove that the media made the situation worse, for the simple reason that it is a global phenomenon that is rooted in massive structural problems in the banking industry and the surpluses and indebtedness of particular countries. One does not want to be trite, but there has been $15 trillion of global support for banks from taxpayers—it is inconceivable that you can lay the blame for that at the door of the media.
In our earlier evidence session, Alf Young—whom I am sure you know—suggested that the nature of the economic times that we have just been through is such that it casts a doubt on whether sustainable economic growth is an appropriate objective for Governments. That is a big picture question. Has the big picture of the economic world that you report—quite apart from the detail of the regulatory legislation—changed?
All sorts of interesting questions are being asked about the right goals for the stewardship of the economy. I am stating the obvious; I am sure that you already know that.
The interesting spin-off benefit for many people—although few would say that it is worth it—is that CO2 emissions have been reduced during the economic shock. Few would say that we would want to engineer an economic shock as a coherent policy on global warming. However, such a fall in emissions rather bolsters the case against those who say that aggregate growth that does not take account of some long-term costs is simply the only target that matters; that, for example, we must return to 2 or 3 per cent GDP growth, irrespective of the costs that are generated in the process. That is an important question, and it is probably a good thing that it is now being debated with a bit more urgency than it previously was.
When there is a bail-out of the scale that we have seen, it is appropriate to ask questions about the relationship between citizens and a particular big part—in this case, the financial part—of the private sector, and about whether those institutions understand that, since their dependency on us has been proved, they have more of a responsibility to think about their role in wider society. It is not obvious that that has happened, and we have not yet heard an interesting speech on the subject—except from Stephen Green of HSBC, who has tried to talk about the role of banks in a wider societal sense. Very few bank executives think of what they do in that way: they think of their role purely in terms of their balance sheet and profit growth. Many would say that this is the moment when executives ought to recognise that there are wider issues that they need to address head on.
Credit rating agencies were passing off certain bonds as triple A, when they were quite clearly junk. Have those agencies got off quite lightly so far?
It is certainly striking that the structure of that industry has not changed very much at all, despite the fact that hundreds of billions of dollars of stuff that they said was solid gold turned out to be rather nearer to poison. It is odd that there has not yet been wholesale, enforced structural reform of that industry. The regulator is still looking at that, and there are various proposals out there.
Many people have pointed out that there is an inherent conflict of interest in credit rating agencies being paid by the vendors of the debt and not by the purchasers. It is odd that that system has not been reformed yet. It also seems to me to be slightly odd that the authorities themselves are, in a way, sustaining the credibility of the credit rating agencies. For example, in some of the schemes that the Bank of England operates to provide liquidity to banks, the only assets that it will take from the banks are those that are rated as triple A by the rating agencies that apparently made so many mistakes on collateralised debt obligations and on the ratings of institutions such as the monoline insurers. Some would say that it is paradoxical that an institution such as the Bank of England is, in a sense, providing a rather healthy business stream for institutions that are part of the problem. The whole area is certainly work in progress.
There is a slight conflict in what we are asking banks to do, given that we want them to shore up their balance sheets while maintaining or increasing lending. The Treasury has indicated that it wants lending back to 2007 levels, but the Bank of England has said that it could go back only to 2004 levels. The committee has to consider the lending situation, because businesses tell us that they are being squeezed. Individual banks say that they are lending just as much, if not slightly more, as they ever did. In addition, the British Bankers Association said in evidence that all its members are lending as much as they ever did. However, banks cannot shore up balance sheets and increase lending at the same time.
Do you have a view on lending policy? Are all the banks lending as much as they could, or is there a discrepancy between them in that regard? Are businesses right to say that they are being squeezed?
The picture is complicated. The first thing to point out—you know this stuff—is that many lenders have withdrawn from the British market. For example, the Irish banks are not lending what they were, because they have problems of their own; the American banks have retrenched to a large extent; and the Icelandic banks have disappeared. Further, all sorts of special lending vehicles collapsed or were wound up, particularly in the mortgage market. The Treasury calculated that, simply as a result of the withdrawal of credit from overseas and the collapse of many specialist vehicles, something like 50 per cent of lending capacity was taken out of the UK market. That is astonishing, and it caused the mess that we are in. That massive withdrawal of credit was the big, fundamental cause of the economic downturn—that is why it is called the credit crunch.
We must now broadly rely on our indigenous banks, but we expect them to do a number of slightly contradictory things. We want them to lend less relative to their capital resources—we want them to take fewer risks, in that sense—to reduce their reliance on wholesale markets and to lend less relative to their customer deposits. At the same time, we want them to lend more to the economy, at a time when all the credit to which I referred has been taken out of the economy. It is therefore not all that surprising that individuals and institutions are saying that there is not enough credit around.
Given the enormous amount of capital that taxpayers have put into the big banks and the enormous amount of pressure that politicians have put on the banks, the RBS, Lloyds TSB, HSBC and Barclays are probably making a bit more credit available than they were a year ago. However, making credit available and getting people to borrow are two separate things. That raises the question whether banks are providing credit on reasonable terms to creditworthy borrowers, which is, of course, where the argy-bargy and disputes arise. Many companies think that they are very creditworthy, but the credit lending officer at the bank will take the view that times are hard and that to lend to them might well be a case of throwing good money after bad. In the end, I guess that few of us would want banks to lend to institutions or individuals who cannot repay the loan and in a sense there will always be an element of subjectivity in assessing creditworthiness.
My personal view is that, although companies are making quite a lot of noise about not getting enough credit, we would be hearing far more noise if the banks were behaving appallingly. Indeed, there was a hell of a lot more noise from companies during the previous recession than there has been this time round. I am not by any means giving the banks a clean bill of health, but I think that they are probably doing a little bit better than some are giving them—[Interruption.] I was about to say "giving them credit for", but never mind.
Of course, the statistics can be read in two ways. According to the aggregate statistics, for example, banks are lending less to businesses at the moment. However, I know from my experience with business that there are a number of businesses that, for a variety of reasons, want to repay debt, and some of that reduction in credit is a result of companies voluntarily and rationally deciding that in this difficult period they have too much debt, they want less and they would rather finance themselves in other ways. Some are lucky to be big enough to raise capital from the bond market, equity and so on, while others have simply decided to retrench for a bit.
Obviously, if everyone did that, it would be bad for the economy, and we need to be acutely aware of that. In his rather excellent analysis of the 15 years in which there was no growth in the Japanese economy, a chap called Richard Koo locates the fundamental problem not in a shortage of credit but in the collective decision of companies to borrow and invest less. We must not get into that position in this country, because if businesses took a collective view that they wanted to reduce borrowing and investment it would be hugely damaging to the country's economic prospects. As a result, we need to look at demand as much as supply. For perfectly sensible reasons, people have tended to focus more on supply, but we should not ignore the suggestion that our companies are simply being a bit too cautious.
I should highlight one final point. People seem to see me as the person to complain to; last autumn, I was inundated with complaints from companies that banks were not behaving properly. I am now receiving a much smaller number of such complaints and if my personal in-box has shrunk in that respect it probably means that the banks are behaving a bit better than they were.
Finally, I want to ask a question that I have put to previous witnesses. Do you think that the Federal Reserve should have saved Lehman Brothers?
I absolutely understand why it did not. Banks that do the kind of things that Lehman Brothers did should be treated as normal commercial organisations are treated when they do stupid things, as Lehman Brothers did. It became far too exposed to commercial and residential property; it took a mad gamble. If the authorities do not allow banks in such circumstances to fail, they give people who earn in a year more than thousands of people collectively earn in a lifetime a blank cheque and enable them to take a bet with our money. That is obviously not healthy. The instinct of the Fed and the Treasury that they had to allow at least some bloody institution to fail was fundamentally right. Unfortunately, they picked the wrong bank at the wrong time.
As you probably know, for at least two years, I have been working 24 hours a day more or less every day. At the end of the week in which Lehman Brothers failed, it was obvious that it had a problem. We were getting messages from the Treasury that it was not going to prop up Lehman Brothers and, all through the weekend, as the bank careered towards collapse, I really could not believe what I was hearing and what was happening. On the Sunday night, when I was aware what was about to happen and reported it on the "Ten O'Clock News", it was obvious to me that it would be a cataclysmic event. It was astonishing that the Fed and the Treasury did not prop up the bank.
Thank you for coming. I think that you are the first non-Scottish commentator who has graced us with their presence.
That is a privilege.
You will appreciate that we are trying to get a perspective on Scotland's place in the crisis, what happened and why it happened. Therefore, the committee finds it strange that, when Scottish Financial Enterprise—the body that represents financial services in Scotland—and the Scottish Government gave evidence, they talked exclusively about the global dimensions of the crisis and were unwilling to offer any comment on its Scotland-specific dimensions. You alluded to some of those when you talked about the ratio of loans to deposits that the RBS and HBOS had. I invite you to say a few words about the Scotland-specific dimensions of the crisis with respect to the management of Scottish banks.
That sounds like an invitation to walk into a minefield so, if you will forgive me, I will be slightly delicate.
It seems reasonable to me to take what happened in Scotland broadly within a UK framework because the regulator is the FSA and the central bank is the central bank for the whole United Kingdom. That is a pretty relevant envelope. In a curious way, Scotland was a victim of success in that it has an extraordinarily strong financial services industry and a proud history in that industry. If there is a Scottish element to the crisis, it is to do with the deposit base.
Many banks throughout the world took the view that the finance available from wholesale markets was, in a sense, a permanent revolution—that that money would be available for ever. Selling mortgages in the form of bonds is the classic example. Plainly, if you are a bank with a regional deposit base and you have global ambitions and very talented people, you have an incentive to raise money from non-conventional means. That was true of Northern Rock, for example. Northern Rock had a relatively small deposit base from customers but huge ambitions in the British mortgage market, and it tapped into the asset-backed security market to an astonishing extent.
The Royal Bank of Scotland and HBOS, through the Halifax merger, had UK-wide franchises and deposit bases. However, their origins within the smaller Scottish economy possibly made them more emotionally open to the notion that there were ways of fuelling expansion other than tapping their domestic deposit base.
One is trying to rationalise why those banks became much more dependent on securitisation and wholesale markets than some other institutions did. However, that is just a function of having a lot of bright and ambitious people, although one has to ask oneself why the individuals at the top of the organisation were not acute enough with regard to seeing the risks.
The phenomenon is not peculiar to Scotland. What I am talking about is a dimension that is peculiar to a smaller economy with people in a particular industry who are particularly talented and have big ambitions. I hesitate to say that the issue is a particularly Scottish one, but I would say that there is an issue about the need to manage growth based on something other than the deposit base.
I hope that that sort of makes sense.
It does indeed.
You have mentioned the size of the bail-out and the $15 trillion stimulus that has gone into the banks. Can you itemise roughly what you think is the size of the taxpayer bail-out of HBOS and the RBS? Last week, we found that the Scottish Government is unable to do that.
Part of the problem is that some of the statistics are available only in aggregate for the banks. I will not, therefore, be able to give you any highly accurate information.
At the moment, some of this is work in progress. As you know, earlier this year, the asset protection scheme was announced. However, Lloyds and the RBS are, at the moment, seeing whether they can raise a bit of capital from the markets, which would reduce the use that they make of the asset protection scheme. Between them, Lloyds and the RBS have just short of £600 billion of assets—I think that the figure is around £585 billion. As well as that, the direct injections of cash that have been made into both of them are worth another £36 billion or £38 billion. The difficulty is that we do not know how much they have placed in the Bank of England's mortgage-swap scheme.
Because the mortgage security market shut down and because banks were so dependent on raising money by selling mortgages to wholesale institutions but that was no longer available, the Bank of England established a scheme whereby it basically took the mortgages from the banks and gave them cash loans in return. One must assume that, in the case of HBOS, that sum of money is substantial. My memory—although you would have to get independent verification of this—is that something over a year ago HBOS alone faced a requirement to refinance around £100 billion to £160 billion of wholesale finance over the following year. One must assume that most of that money came from the Bank of England; it is difficult to imagine where else it could have come from. You would need to get the figures from HBOS, but the sums of money coming out of the Bank of England's mortgage scheme for the two banks together must inevitably run to £100 billion-plus.
There is then the question of how much cash from the purchase of gilts has ended up within the banks. That is impossible to know. We are talking about those two banks certainly being responsible for more than half of the £1.3 trillion. The figure may even be two thirds of that, but it is difficult to say.
There is a common misperception that the only guarantee that has been extended to the banks over the past year is the share capital. As you say, the figure that we used a couple of weeks ago—in so far as there is an estimate out there—was of the order of £100 billion, although it may be more.
It may be more. The other thing, which I forgot to mention, is the credit guarantee scheme. That is the taxpayer-guaranteed sales of short-term debt. The banks are on a life-support machine that is provided by taxpayers—we should be under no illusion about that. If we asked for the money back tomorrow, they would not exist.
It seems highly significant in the Scottish context that in excess of £100 billion in public sector guarantees has been extended in the past year to keep those institutions going. That is more than three times the entire budget of the Scottish Government, but that is not really my point.
Let us return to your previous point. All the talk at the moment is about the need for regulation to be global, but the truth is that rescues have been largely national. In thinking about the future character of Scottish financial services, we must consider whether we are going to be a centre for headquarters functions or a centre for back-office processing. If we have major domiciled headquarters functions that are engaged in extensive financial innovation, will they be underwritten by a domestic central bank that is capable of covering the losses or extending the guarantees in a time of crisis? The other nearby country that was big in financial innovation was Iceland, and its central bank found itself unable to extend the guarantees. It seems to me that, if rescues are largely a national matter, when banks are deciding where to domicile themselves they may need to consider whether a country is of a scale and significance that would enable its central bank to support them.
Another easy question. [Laughter.] Forgive me for not answering directly, but I will respond to your question.
Ireland provides an interesting example. In the autumn of 2008, the Irish Government made an extraordinary announcement when, without consulting any other members of the European Union, it said, "We will guarantee the liabilities of all Irish banks." If Ireland had not adopted the euro, the punt would have gone to nought, because the Government simply could not have afforded those liabilities. I think that you understand what the issue is; it is about wider arrangements than what you are alluding to.
May I ask a final question on a different topic?
You must be brief. We are running short of time.
Honestly!
I am sorry, but I am in charge of the meeting, Chris, not you.
My final question is about competition. When the Office of Fair Trading considered the Lloyds-HBOS merger, it found that the small business banking market in Scotland was highly concentrated and void of any constraints. Together, Lloyds and the Royal Bank of Scotland have 75 per cent of the small business banking market, but the Scottish Government has not a word to say about that. Scottish small businesses appear to be entirely dependent on the European Commission saying that a 75 per cent concentration in small business banking is unsustainable. Is Neelie Kroes doing the right thing on behalf of small businesses while there is silence in Edinburgh on the matter?
She is bound to recommend divestiture that she thinks will introduce more competition. It is clear that that is one of her aims, but that is technically quite hard to do. It is quite an experiment.
Competition in business banking is a hugely important issue. Given that the Royal Bank of Scotland in particular has run a seamless business banking operation more or less for ever, it will, in effect, have to create a business and then sell or somehow offload that newly created business, which will not be easy. Technically, it will be quite challenging.
Let us be clear. The issue is not just one for Scotland. The OFT was more or less aghast that things were waved through for reasons of financial stability. It is a big issue.
I hope that we can get through all our questions. Three other members still wish to ask questions.
I am sorry—I talk for too long.
We have about another 15 minutes before we proceed to the final item on the agenda.
I will try not to be quite so wordy.
I ask members to keep their questions brief.
I will be brief and will not make any party-political points.
On 18 September 2008, after consulting the Prime Minister, the FSA and the OFT, Lloyds took over HBOS for £12 billion. I have been through the blogs that you produced at the time. Sir Victor Blank was unaware of the toxic assets—it has been speculated that there were up to £116 billion-worth of them—on HBOS's loan book, and of the stakes that were taken in top-of-the-boom property and retail companies by HBOS's head of corporate finance, Peter Cummings. Was Sir James Crosby also in that state of ignorance? He is a former chief executive officer of HBOS, and was a member of the Financial Services Authority after January 2004 and deputy director of the FSA after November 2007 when, as you have told us, you already thought that something very rum was up. Was the Prime Minister, who, when he was Chancellor of the Exchequer, appointed him to those positions, also in that state of ignorance?
You will have to ask James Crosby that question. I will, however, make one point, which you are at liberty to interpret how you will.
I interviewed Victor Blank about three weeks ago. He, and all his minders—who went white when we started talking about it—insisted that they were aware of what was inside HBOS. They said that what surprised them—as I said, you can interpret this however you wish—was the speed with which the loans went bad, but they claimed that the quantum, or £20 billion of losses so far from HBOS, was at the upper end of what they feared but not outside the range of their expectations. Now, they are being sued by shareholders and are facing court cases almost everywhere, so you might want to interpret those remarks in that light.
It might be worth reminding everyone that we do not have parliamentary privilege to the extent that Westminster has.
You were very benign in February 2008 in "Who Runs Britain?" when you postulated a possible total global loss to the banks of £13 billion in aggregate. That was on page 32.
Did I? That was a mistake.
If my reading of a recent Financial Times and my poor arithmetic add up, the total losses in Britain came to—
My figure was from autumn 2007. I will have to go back and look at that.
The total losses were at least £480 billion, according to the FT of about a month ago.
Oh, it will be miles more than that. The losses to the banking system will be something like £2 trillion.
I am arguing the fact that we knew so little about the banking structure. I was talking to Tom Burns, an expert in banking law from the University of Aberdeen, who wanted to do a thesis on the law of securitisation but found that there is no such law and that securitisation is completely in computers. What worries me about that is that Sir Callum McCarthy, head of the FSA during its light-touch days—I think that is the first time the term "light-touch" has been used this morning—pointed out that criminal gangs were infiltrating the City of London structures. That was in The Guardian in June 2005 or thereabouts.
In 2005 and 2006, we as observers, and the then chancellor, were obsessed with potentially immense carousel frauds of VAT and the Inland Revenue. Brown himself admitted that the sums were as high as £2.75 billion, but said that he had the situation under control.
I had a letter from Bill Keegan, the economics commentator with The Observer, from Singapore in September of that year saying:
"All I can say is that at Singapore last month, one needed several hands to count the number of people who were concerned about the possibility/probability of a great Regulatory Failure!"
Were those danger signals misinterpreted, ignored or suppressed?
A huge number of investigations are going on all over the world; it is a case of stable doors and bolting horses, but regulators everywhere are digging inside banks to see whether there was fraud. I think that the suppression element would fall into that category.
It is clear from the conversation that we have been having today that warning signals were ignored, but it was slightly worse than that. Among some regulators and quite a few banks, there was a sort of religious fervour that what was happening was either benign or positive. The point is not that lots of people were shouting very loudly, "This is all very bad." The point is that rather too many people were shouting very loudly, "This is great." They were saying that the world was a safe place because all the risk had been taken off banks' balance sheets, with little parcels being distributed to all the investors, and that therefore the risk of significant problems for any particular institution in a downturn was greatly reduced. That was just bonkers.
Not if you read Eric Ambler back in the 1970s. He sussed it out in his final thrillers. The theory came from the University of Glasgow, where a sociologist called John Mack and a Tübingen criminologist, Hans-Jürgen Kerner, produced the thesis of the clever criminal who remained in a largely computerised, tax-havened and global framework. The theory was around as long ago as that.
There will be an opportunity to continue that discussion over lunch.
One question that the committee posed in announcing the inquiry was:
"How can we ensure that the Scottish financial sector continues to retain a global perspective and does not retreat into a purely localised lending regime?"
With the RBS restructuring, it is expected that its operations will be reduced or sold in 36 of the 54 countries in which it operates, and that it will centre on the UK with tighter and more focused global operations. Might the RBS become inward looking and boundary oriented in the UK, give or take one or two exceptions elsewhere?
That is certainly not the ambition of the current management—at least, not going by what they have said to me. Patently, the ABN AMRO deal was a deal too far. It is perfectly rational for the bank to shrink a bit as a result of that deal and other decisions that it took prior to the deal. It is not obvious that that is necessarily a bad thing. The RBS still thinks of itself as having global ambitions. It is retaining one bit of ABN AMRO—its global payments system–that more or less all banks say was good. In that sense, it is firmly committed to remaining an international bank, but one that is rather less thinly spread.
In a way, the more important point is about the fact that the RBS is one of the universal banks—a conglomerate that is big in investment and retail banking. To return to where I started, it is possible that after a long debate we will decide that such structures are inherently dangerous and that we want banks such as the RBS and Barclays to be broken up. At that point, depending on what role you think the RBS plays in the Scottish economy, there might be an interesting public policy issue. By definition—and like it or not—the investment bank part will gravitate to London. It already largely operates out of London, anyway, but there would be a wholesale divorce. At that stage, an issue would arise about whether you thought that was damaging for the economy.
I have a question about European Union state intervention. With EU state aid, one aspect that must take place is the restructuring of organisations. Some EU nations tend to have a reputation—rightly or wrongly—for being protectionist of their industry. First, what is happening in terms of European restructuring? How are member states dealing with that? Secondly, what is the potential threat to inward investment in Scotland? Earlier this year, BNP Paribas announced that it is going to set up a facility in Glasgow, which will create 370 jobs. I am concerned about the potential impact of the situation in other European nations on Scottish jobs.
You are taxing my knowledge base, to be frank. People forget that Neelie Kroes is looking at all banks in Europe that are in receipt of state aid, not just the British ones. It will be interesting to see what she does in other parts of Europe. She certainly does not think of herself as somehow discriminating against Britain or against doing a particular British thing. It just so happens that we had a particular problem in this country and the scale of the bail-out here was bigger than in other parts of Europe, so a big part of her work is based here.
It is not clear to me that there is any threat from Europe. Why do you think there is a threat from Europe to inward investment in Scotland? It is not on my radar at the moment. Why is it on yours?
I do not want to mention particular countries or industries, but one sticks out in my mind. In the past, a particular EU nation has had a reputation for being extremely protectionist in terms of what it can provide and what it gives to its workers. With the restructuring that has to come with the provision of state aid, how would the Government of that particular EU nation try to deal with matters within its own boundaries? Could that have a knock-on effect on inward investment in Scotland or elsewhere within the UK or other EU nations?
You will be a better judge of that than I am. A lot of people believe that the UK rolls over faster when Europe tells a particular company to do this or that. Whether that is true is for others to judge. Neelie Kroes is a pretty formidable individual and it seems unlikely that anything that she did would be seriously discriminatory against the UK or Scotland. We will just have to wait and see.
Thank you for your patience, Robert. You have been asked some taxing questions so far. Members have clearly been studying your blogs. Blogs must be the curse of BBC journalists now, because anything you write comes back to haunt you. I will finish with a couple of easy questions about bank bonuses.
We are looking forward towards the effect on the banking industry in Scotland. You said that you are the person to whom people complain. Have you received complaints from your friends in the banking fraternity about attempts to curb their bonuses?
No. We have talked about the scale of the bail-out. Most people find it extremely odd that, in those circumstances, the banks have not made more of a voluntary—"gesture" is not quite the word that one wants to use in the circumstances. They find it odd that the banks have not simply stood up and said, "Until we're free of this kind of support, we will collectively change the way we pay people."
I am sorry to interrupt but, earlier, you mentioned that there is only one banker who is speaking about the role of those institutions in the wider society. Do you think that there is a collective failure on the part of senior bankers to understand that they have a role to play in the wider society and that now is perhaps not the time to be paying themselves mega-bonuses?
For reasons of editorial impartiality I cannot put it quite as starkly as that, but the fact is that it seems to me that it is not unreasonable to draw that conclusion.
I am asking because when I met some financial people last week and the question of bonuses came up, as it always does, they got very irked about the fact that their bonuses were under attack. They also said that they believe that stopping bonuses could damage the financial services industry in Scotland. I do not agree with any of that, but you were saying that there is a possibility that investment banking could migrate south.
I was making a separate point about what would happen if you broke the Bank of Scotland up into two parts.
This is quite a tricky issue. For many people, common sense suggests that, given that we rescued these banks from a failure of colossal proportions—if the taxpayer had not given a blank cheque to the banking system in that crucial autumn, not a bank would have been left standing—it is extraordinary that bankers should be receiving bonuses.
Further, if you look at the activity that is generating the profits that are generating the bonuses, you will see that a lot of it is to do with the extraordinary amount of activity that has resulted from central banks flooding the markets with liquidity, Governments borrowing bonds, companies trying to raise new capital to reduce their borrowing and so on. A lot of the activity is directly created either by Governments trying to protect the economy or by private companies trying to shore themselves up in the wake of the mess that many would say the banks caused. In a sense, a lot of that activity is a result of attempts to clean up the banks' mess. Some would say that it is inappropriate for bankers to receive enormous bonuses in those circumstances. Indeed, Adair Turner, the chairman of the FSA, said that just the other day.
The counter argument that you will hear from the bankers is that there is a global market and, if they do not pay these enormous bonuses, they will lose people to rivals who are prepared to pay the bonuses. That seems to be a perfectly legitimate thing to say. However, the thing that is slightly odd is that, given that this is an industry that, historically, has been among the most collusive in the world—although, admittedly, there has been a bit more competition in recent years—chairmen seem to be incapable of ringing each other up and saying, "Actually, if we wish to become marginally more popular than Atilla the Hun, we should collectively cease paying bonuses for a bit." It is a bit odd that they are incapable of acting collectively on this. There is little more that one can say.
In your blog, you said:
"In the Netherlands, for example, a ceiling is being imposed on the absolute amount in bonuses that any particular banker can receive."
Is that something that we should consider?
The problem with action by individual countries is that there is a genuine risk that people will go and work elsewhere. If, for example, the UK unilaterally imposed such a measure, it is possible that quite a lot of British bankers would go and work for American banks that do not have such a ceiling, which might do a bit of damage. My point is that Americans do not love American banks any more than Britons, at the moment, love British banks, and banking is global. The thing that I do not understand is why banks are not talking to each other across borders about this issue. Damage is being done not only to the reputation of British banks but to the reputation of banks everywhere. It is odd that banks refuse to grasp that particular nettle.
There is a fundamental question that we do not have time for today, which is the extent to which we should worry about a few bankers going off somewhere else. This is not so much a Scottish issue as it is a UK issue, but the heart of the matter involves the extent to which the UK took the view that the bigger the City, the better. It is plainly the case that we went far too far in thinking that everything that went on in the City was for the good. Broadly, over the past 10 years, every time there has been a tax issue or an issue to do with the costs of people in the City, we have immediately heard people saying, "If we tackle that issue, a load of hedge funds will go to Geneva and a load of private equity firms will move away." However, in the end, we must ask ourselves what sort of structure we want our economy to have and how many eggs we want to keep in the financial basket.
Whether we should be imposing ceilings on bonuses and so on plays into a much wider question about how big we want the financial industry to be in our economy. You cannot see the issue in isolation from that question.
Thank you for a fascinating question-and-answer session. I am sure that we will get a lot out of it as we go on with our inquiry.
Before I briefly suspend the meeting to allow Robert Peston to depart and to allow the hundreds of people who want to hear our deliberation of the Arbitration (Scotland) Bill to come in, I put it on record that we have appointed Philip Augar as our adviser for the remainder of the inquiry. I remind members that, because we will be dealing with the budget during October, it will be November before we return to this inquiry.
I thank you again, Robert. Some of us will join you for lunch after the meeting.
Thank you very much. I enjoyed today's meeting.
Meeting suspended.
On resuming—