Oakeshott and Kramer on the Independent Commission on Banking

• [Sep 15] Lord Oakeshott of Seagrove Bay (Liberal Democrat): MY Lords, I declare my interest as a pension fund investment manager for the past 35 years. Noble Lords may be surprised to hear that for half of that time I have worked in banks. I am also a friend and former colleague of Martin Wolf and Martin Taylor. The noble Lord, Lord Liddle, handed out marks to John Vickers. As one who sat at his feet at an Oxford college and did not learn nearly as much hard economics as I should have done, I am happy to give him a pure alpha, although he never gave me one.

The noble Lord, Lord Myners, certainly knows how to damn with faint praise. He is too grudging. This is an excellent piece of work by Sir John and his colleagues. I believe that it is also an example of the old adage that politics is the art of the possible. Certainly, I and many others would have preferred a complete separation, but we are in a coalition rather than a Liberal Democrat Government, so we must be realistic about what we can get through. Sir John has judged it very well. I say in particular, to those who have waded through to the last 100 pages of the annexe, that he has shown brilliant tactical sense by smoking out all the banks' objections in his interim report and then shooting them down in flames in his final report. That is why, like the noble Lord, Lord Newby, and others, I believe that it is essential that we get on with reform now. The banks have had ample time for special pleading and talking to No. 10 and No. 11. Parliament is now the right forum to progress reform, and in particular the expert Joint Committee that is starting pre-legislative scrutiny on the financial services Bill.

I see the noble Baroness, Lady Valentine, looking expectantly at me. She sent me a text just before I started, saying that she was looking forward to lots of fire and brimstone. I am sorry that I have to disappoint her. We have had plenty of that already the past few weeks, not least from me, so I will focus on two key points. I have touched already on one: timing. On radical bank reform, we have won the argument about "whether": we are now on to "when". We should look at what the Vickers report said. There was a lot of shorthand this week about 2019, and the noble Lord, Lord Griffiths, repeated it. The report stated:

"The Commission naturally hopes that Government and Parliament will respond positively to its recommendations by enacting reform measures soon. Early resolution of policy uncertainty would be best".

I will say from very long experience of turbulent markets like these that markets can live with almost anything except uncertainty. Given that the Government have clearly taken the decision, there is every case for getting on with it.

The commission also said that the Government should, "provide clarity about its view of the Commission's recommendations as soon as possible",

and, "move rapidly to put in place the necessary legislation and rules".

It also made it very clear that 2019 was a longstop date for final completion of all the details. That is perfectly logical for getting up to the final capital requirements, but it is no argument for delay on crucial structural points.

Finally, the commission points out that, "the economic conjuncture certainly does not reduce the need for financial reform".

You can say that again. It states: "On the contrary, it reinforces the need to make the UK's banking system more robust".

Today's horrific news that a so-called rogue trader has struck again, this time at UBS, reminds us how much toxic banking risk remains in the system, and how urgent radical reform is. The problem is that big investment banks are full of rogue traders: it is what they do.

Secondly, I will say a word about culture and governance. Again, the Vickers report is right when it points out that it is difficult for regulations to work effectively when they operate against the grain of corporate culture.

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Lord Marlesford (Conservative): Perhaps I may say that I just do not think we can let the noble Lord say that this is what rogue traders do. Traders work on behalf of their bank. Rogue traders exploit their position to do things that are not on behalf of their bank. There is a total distinction between traders and rogue traders. For the noble Lord to put them together is absurd.

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Lord Oakeshott of Seagrove Bay (Liberal Democrat): If I may say so, the noble Lord has put his finger on it; the trouble is that all these traders are working on behalf of their banks and it is about time they started working on behalf of their clients. There is a real problem of control when there is such a bonus culture and so much risk in the system.

I will move on to how we implement the separate culture of the ring-fenced retail banks, as the Vickers report recommends. The report makes another excellent and important point when it states that there is already a model in the utilities sector, where, "independent boards are a standard requirement",

and that, "board independence was crucial to the survival of Wessex Water despite the collapse of its parent, Enron".

The report recommends that on the board of the ring-fenced bank there should be a majority of directors who are independent non-executives, with a minimal crossover between these directors and members of the group. That is vital.

I see in her place the distinguished former business editor and national newspaper editor, my noble friend Lady Wheatcroft, who incidentally is on the Joint Committee. I hope this does not put the mockers on her chances, but I think that she would be an ideal chairman for a ring-fenced retail bank, particularly with her recent experience on the board of Barclays. Sorry, Patience.

The Vickers report concludes:

"While corporate culture cannot be directly regulated, these measures should assist in building a separate, consumer-focused culture in UK retail banking".

Like the noble Lord, Lord Lawson, I remember the banking set-up in London in the 1970s and 1980s, when I was at Warburg. We can recreate that within the safe part of banks. I share the worry of my noble friend Lord Newby about Bob Diamond saying that he can live with it. I very much hope that that is because he does not think that it will be implemented. Let us prove him wrong. People like him are light years away from the objectives and culture of, for example, Barclays' Quaker founders. They did not gamble or avoid tax. They saw themselves as stewards of people's savings, which they lent prudently for productive purposes so that their fellow citizens could work and prosper. That is the spirit we must recreate in our ring-fenced retail banks to make them safe. Let us get on with it now.

• . . Baroness Kramer (Liberal Democrat): MY Lords, in congratulating the noble Lord, Lord Myners, on achieving this debate, perhaps I may say that as I listened to him, I indeed thought of the Chinese meal that he described. He clearly got to the end, opened the fortune cookie and found a fortune that said, "Vickers has given you all that you asked for". Then, given his position on the Benches opposite, he felt that he had to attack it for not dealing with every financial and banking problem nationally and globally. Vickers is just part, albeit a crucial and important part, of resolving our economic banking and financial crisis. We should be welcoming this with enthusiasm.

For my sins, for 15 years I was in the banking trade, primarily in the United States and in central and eastern Europe. One of the consequences is that I am a cynic. In my time I saw banks decline on the back of at least two devastating collapses in real estate markets, following the collapse of heavy industry in the north-eastern United States. I joined the Continental Illinois bank on 5 July 1982. On that morning it was the most prestigious bank and the largest lender worldwide to businesses. By that evening it was clear that fraud and incompetence in oil and gas lending had utterly destroyed the institution. But all that could be dealt with in that period because, essentially, the failure was contained. There were rescue plans, acquisitions, mergers and restructurings, but the banking system as a whole did not tumble as a consequence.

That is the change that we face today. The crises will not end, but we now live in a world of interconnectedness. That started out as a mechanism by which banks could manage risk, but essentially, through structured finance and derivatives, and the layering of transaction upon transaction on the back of an individual initial loan, a situation has been created where, rather than just the bank that directly made a stupid or fraudulent loan finding itself at risk, the whole system can be pulled down after it. What I so appreciate about Vickers is that it takes a sword and strikes right through that interconnectedness. Surely that has to be essential in what we do. The deep structural change being proposed is also, I would suggest, very hard to erode. I said that I am a cynic, and as a consequence of that, I do not believe that regulation, supervision or even living wills can, by themselves, eliminate or enable us to deal with systemic risk in our system.

Noble Lords might think that the regulators had no way of knowing in 2008 that we were entering a financial and banking crisis. Indeed, the noble Lord, Lord May, described the absence of various forms of systemic analysis that he is now hoping to introduce. But, frankly, if you ignored the top bankers and talked to the people I know-I have certainly never been a top banker or a board member-one person after another could have told you that the loan books were going wrong, there was bad stuff in them, there was a lack of transparency and a crisis was coming.

The noble Lord, Lord McFall, is no longer in his place, but he was chair of the Treasury Select Committee on which I served briefly. We were in the United States in January 2006 and we talked extensively with investment bankers. Again and again they would say to us quite casually, "You understand that there are storm clouds gathering and a major crisis is coming in 18 months to two years off the back of some of the ridiculous home mortgage lending that has been happening in the United States", and they mentioned various other problems. Trying to tell the Treasury about it was absolutely impossible. Trying even to tell the Americans via the British embassies in the United States was impossible. There was a sort of dewy-eyed belief in the investment banking system, and the regulators caught the same disease. It strikes me as something that is inherent at the top levels of the banking system. I noted when reading Alistair Darling's memoir that the arrogance tends to come through. However, it is not the case for everybody.

Banking is an industry in which structural barriers have to be put in place. You cannot rely on regulation and supervision, not just because of the frequent absence of common sense but also because I think that we can guarantee that the leaders of our various banking institutions will, within 36 months, be back in through the door of the regulators and the Treasury trying to persuade everyone to go back to a much lighter touch. It is far harder to change structural division than it is to constantly amend regulation at the fringes. That is why it is absolutely crucial.

Many noble Lords have talked about the increased costs involved in separating the banks, and I fully accept that. However, there are some counterweights, and I again recall my own time in banking. When there was separation of companies which by culture and by customer focus essentially did not belong together, both received a new lease of life. Retail banks are suddenly free to be genuine retail banks, with different training and corporate structures, and can look at their customers in a different way. They should become far more competitive and responsive, and much more competitive in terms of price than one might think given the difference in their capital ratios and the additional costs that fall on them.

Indeed, we might even see some new excitement and innovation in the investment banks when they no longer find that everything they do is masked by the pool of retail deposits. When they have to face that reality, I suspect that they will be equally innovative. That is one of the reasons why I am happy to say to the noble Baroness, Lady Valentine, that I am not afraid for London's pre-eminent position. The artificial intermingling of two very different kinds of institution has been demonstrated in other industries to do no one any good, so I do not think that we are going to see the kind of damage which many have been afraid of.

I have two final comments. The first is that it would be interesting to have an opportunity to focus much more on the whole range of measures that are being used to deal with our financial and banking crisis. I was struck by the concerns expressed by Donald Kohn, an external member of the Financial Policy Committee, about the lack of transparency and, "the re-emergence of complex instruments with chains of counterparty exposures that are not transparent or well understood".

We have talked in this House about "dark pools". There are a lot of issues that have to be dealt with alongside because we have highly fragmented financial markets. We are also seeing relatively little in terms of international co-ordination at the moment. If one thinks in terms not just of Vickers but of Basel III, the EU capital requirements directive IV, the Dodd-Frank Act in the United States, the EU insurance industry Solvency II rules, one sees myriad things happening. I should love to hear from the Government that we are seeing some co-ordination among all this, because fragmentation makes decision-making difficult.

The noble Lord, Lord Sawyer, was one of the few noble Lords who spent a lot of time talking about the change in the competitive environment for retail banks. I am going to take this chance to make one last plea: that one of the considerations for the bank that comes in and joins our high street is that it will service micro and very small businesses and economically disadvantaged individuals who are of no interest to our mainstream banks. If we could kill those two birds with one stone, I would find Vickers to be something close to a perfect report.

• Full Debate in Parliament