On 8th September 2016 the Bishop of St Albans, Rt Revd Alan Smith, led a debate in the House of Lords: “To ask Her Majesty’s Government what is their assessment of progress towards implementing the recommendations contained within the report of the Parliamentary Commission on Banking Standards, Changing banking for good.”
The Bishop’s opening speech is below, followed by the response of the Minister. Other members spoke in the debate, including the Archbishop of Canterbury (speech here) who had served on the Parliamentary Commission on Banking Standards.
The Lord Bishop of St Albans: My Lords, I start this debate by saying how pleased I am to see the Minister responding today in his last time in his present role, although I look forward to working with him when he takes up his new duties at DCMS.
We are now three years on from the publication of the parliamentary commission’s report Changing Banking for Good. Thanks to the decisions made by this and previous Governments, our banking system is taking tentative but important steps along the road to recovery. We must not forget, however, the blunt summary in the report which laid out the scale of the problems with banks over the previous decade:
“Banks in the UK have failed in many respects. They have failed taxpayers, who had to bail out a number of banks including some major institutions, with a cash outlay peaking at £133 billion, equivalent to more than £2,000 for every person in the UK. They have failed many retail customers, with widespread product mis-selling. They have failed their own shareholders, by delivering poor long-term returns and destroying shareholder value. They have failed in their basic function to finance economic growth, with businesses unable to obtain the loans that they need at an acceptable price”.
Some people, not least some bankers, claim that this is now all in the past and that today everything is different. However, even a cursory glance at our newspapers reveals the catalogue of problems that continue to dog some parts of the industry.
I will focus my comments on those recommendations of the commission which sought to shape the corporate culture of our banking institutions. The banking crisis of 2008 was, after all, not primarily a regulatory failure but a moral failure. It was a failure of a corporate culture that came to reward irresponsible and reckless behaviour, eschewed accountability among senior managers and failed to value the interests of its customers, and which refused to acknowledge its duties and responsibilities to wider society.
By the time the commission’s final report was published in 2013, it was clear that the banking industry had become detached from the moral moorings that had helped to shape its activity over past centuries. Gone were the principles of collective endeavour and mutual success, to be replaced by a misalignment of risk and reward which had stripped many parts of the industry of any substantive values besides the pursuit of short-term capital return.
While a tightening of the rules could help bring broken banks into line, the parliamentary commission quite rightly noted that the task of reform would remain incomplete while banks and regulators continued to see those regulations as little more than boxes to be ticked. What was and is still needed is a renewal and a re-embedding of the values by which banking is governed. Only when banks themselves come to take seriously their long-term responsibilities towards customers, employees and the common good will they find themselves in a position in which they can regain trust.
The commission therefore made a number of recommendations aimed at encouraging this renewal of culture and values. Increasing accountability at the top of banks through the new senior managers and certification regimes should help to concentrate the minds of senior management on the importance of embedding good corporate values throughout the bank. The new set of conduct rules and the requirement that banks train staff in their implementation will set a basic standard of values against which all staff can be held to account. Finally, the new rules on remuneration, with a proportion of any bonuses deferred and new facilities for clawback and malus, should strengthen the alignment of individual rewards with long-term risk.
The Government’s willingness to implement these recommendations is welcome, even if there has been some hesitancy to implement them in full—for example, the extent to which remuneration should be deferred. However, the effectiveness of these reforms has yet to be tested, and that will be an important part of the process. Can the Minister inform us what will be done to monitor the implementation of these new rules and regulations? Will Her Majesty’s Government report, for example, on the number of senior managers being held to account by the regulator? Will they keep a public record of the number of staff being disciplined for failing to abide by the conduct rules or on the number of cases of banks exercising their right to clawback remuneration? It is no good banks and regulators being given these new powers if they never actually use them.
These regulatory changes are crucial steps in helping to reshape at senior levels the culture of British banks, but cultural change must go deeper than the top layer. It needs to become embedded within middle management: those individuals who actually drive sales and investments. There is of course a serious question as to how far regulatory changes can successfully embed cultural values into the heart of any organisation —as large, for example, as Barclays or HSBC. Cultural change has to come, at least in part, from within the industry itself.
In this regard the creation of the Banking Standards Board, as recommended by the commission, is an important step towards a sustainable and responsible banking system. The BSB is in a unique position to encourage and facilitate banks to move in a more sustainable direction. It can employ the soft power of public opinion and help to share examples of best practice. It also holds the key to the professionalisation of an industry that has often lacked proper accreditation standards.
I urge the board to act boldly in holding its members to account, but Her Majesty’s Government also have a vital role to play. Crucial to the BSB’s success is a competitive market, but I fear that the recent recommendations from the Competition and Markets Authority do not go far enough in driving transparency and competition, or in levelling the playing field for challenger banks.
Beside the BSB, responsibility for cultural change in banking also requires senior management to ensure that it is rewarding, promoting and embodying those values that are commensurate with the long-term health not just of its organisation but of its customers and the wider economy—the common good. Since the crash, a number of CEOs and senior managers have made cultural transformation a top priority of their tenure. However, it is worth noting that many of them have faced huge problems in maintaining and increasing short-term shareholder returns.
Herein lies a core problem for banking that is noted by the commission but remains unaddressed. While it is clear that long-term thinking over investments, debts and customer care is integral to the sustainability of any bank, there is an inevitable pressure to focus on short-term returns when the average share is held for just six months. Keeping shareholders happy remains the central priority of senior management. As long as that continues, regulations protecting the wider economy will continue to be seen as a hurdle to be cleared and short-term gains will continue to be pursued at the expense of long-term stability.
The parliamentary commission made a number of recommendations on this, including consulting on changes to the Companies Act to remove shareholder primacy in the case of banks that posed a wider economic risk, replacing that with a primary duty to financial safety and soundness. As far as I am aware this is not something that Her Majesty’s Government have acted upon. Can the Minister comment as to whether this sort of approach might be considered by our new Prime Minister? Can he also inform the House what impact the UK’s impending withdrawal from the EU might have on current and future banking reforms?
The Parliamentary Under-Secretary of State, Department for Culture, Media and Sport (Lord Ashton of Hyde) (Con): My Lords, I am grateful to the right reverend Prelate for securing this debate here today and to all noble Lords who have spoken, including distinguished members of the commission itself. I am also grateful for the kind words of those who were wishing me godspeed on my way. There is always doubt as to whether they are longing to get rid of me or want to come to see me in another form.
The theme around today’s debate is that we all acknowledge the problems. We realise that they were incredibly serious and that they had an effect on real people’s lives all over the country. Therefore, the issue demands a huge amount of attention, not only when the commission took place but also as it continues, so it is good that we are having a debate such as this today. There is a theme that some progress is being made—or is it illusory?—and that competition is necessary but consumers should be served well and fairly. I hope to be able to convince noble Lords that real progress is being made and to answer a lot of questions.
It is also helpful that the noble Lord, Lord Davies, took the time to mention that this is a very important industry for the country. It employs 1 million people, two-thirds of whom are not in London and the south-east. They raise £60 billion of tax revenue to pay for things that we all want, such as hospitals. It is very important in the context of Brexit, which I will come on to later. It represents 12% of UK exports.
I think we all agree that the report is an exceptional piece of work. It identified fundamental problems within the banking system and clear solutions to them. In the wake of the financial crisis and a succession of scandals, though, public trust in our banks has undoubtedly been dented, so it will take not only legislative and regulatory reform but a long-term shift in culture if the industry is to fully restore that trust. Culture is a theme that came up throughout the debate.
I shall summarise some of the progress that the Government and the regulators have made in response to the commission’s main recommendations. The noble Lord, Lord Davies, asked me to comment on individual responsibility. A key focus of the commission was the so-called accountability firewall that allowed senior individuals and banks to evade responsibility for serious failings in their firms. Criminal sanctions were introduced for senior managers who recklessly cause their banks to fail, and who can now face up to seven years in jail. We have significantly strengthened the regulator’s ability to hold senior managers to account through the new senior management certification regime, as we were reminded by the right reverend Prelate. This ensures that all the senior managers and key decision-makers in the firm have statements of responsibilities setting out clearly what they are accountable for, enabling the regulator to hold these individuals personally to account if things go wrong. This is because there is now a statutory duty on senior managers to take reasonable steps to prevent regulatory failings on their watch.
There are strong incentives to take such steps because the penalties for breaching the duty can run to an unlimited fine, and firms must review the fitness and propriety of key staff on an ongoing basis. In short, we have taken the steps to create a culture of accountability, sending a powerful message to both senior and junior staff that good conduct is their own personal responsibility.
The regime is still young—it came into effect for deposit-takers and large investment firms in March—but we are already seeing evidence that firms are taking it very seriously. I will come on to the monitoring in a minute. From 2018 the regime will start to be applied to all other authorised financial services firms and firms where misconduct that can undermine the integrity of the market and let customers down can be caused by failings similar to those identified by the commission in banks.
So much for the stick. The commission’s report also highlighted the importance of getting the carrot right. The actions of individual bankers are also influenced by the system incentives that are in place, and again the linkage between risks and incentives was a theme in the debate. As the right reverend Prelate said, one of the roots of the financial crisis was the system of incentives and rewards that existed within financial institutions that meant that the long-term risks were poorly aligned with the short-term rewards. In responding to the commission’s recommendations for reforming remuneration practice, we have created the toughest regime for any major financial services centre. All firms must be able to claw back bonuses if it subsequently emerges that an individual has not met robust ethical and professional standards expected of them. For those who are high earners, or who take significant risks for the firm, at least 40% of any reward must be deferred over five years at least, and at least half must be paid in shares. The Bank of England has also laid out proposals that will enable bankers’ bonuses to be revoked after they have moved employer in the event of misconduct.
As a result of these reforms we have seen a big increase in deferral periods and payment in instruments, with the industry clearly moving away from the kind of remuneration system that promotes a culture of short-term gains over long-term profitability and stability. However, the legislation regulation can only go so far. We think it is important that businesses take responsibility for reform in their own culture.
The commission recommended the creation of a professional body to promote high professional standards, and we are seeing progress being made. The Banking Standards Board, established in response to the recommendation, now has 32 members ranging from the largest banks and building societies to some of the smallest, and has begun valuable work to support a strong banking culture. For example, it has run a comprehensive culture assessment of banks and building societies in the UK to show them their scores benchmarked against their peers along with an analysis of key issues facing their firm. In response to a recommendation by the Fair and Effective Markets Review, the FICC Markets Standards Board was established to improve conduct in wholesale fixed income, currencies and commodities markets, which the noble Lord, Lord Haskel, mentioned. It has already taken important action, publishing some draft industry standards. Therefore I, with the right reverend Prelate and other noble Lords, look forward to seeing how the work of these bodies progresses.
In the limited time available I will address specific comments and questions from noble Lords. We agree that competition is important and that it is important to have more of it in banking. However, the CMA report shows that there is more to do. We welcome the report and will be responding within the 90-day deadline; I think it reported in August. We agree that it is not the end of the debate and will continue to keep a firm eye on the actions that may be required to create a more competitive market.
The most reverend Primate talked about the lack of new entrants in banking. There has been progress on that. We saw one new retail banking authorisation up to 2010 and we have seen 11 new retail banking authorisations since then; shortly we will see some of those names filtering through. However, of course, as the CMA report showed, there is more to do.
The right reverend Prelate asked to what extent the remuneration should be deferred, saying that it was inadequate. We have gone some way, deferring it to five years, which was an extension from three. For senior managers the deferral period was seven years in response to the recommendation of 10, so we are not that far apart.
The right reverend Prelate and the noble Lord, Lord Davies, asked how we are monitoring this, which is an important question. The regulators will keep a public register that will show suspensions and restrictions of public enforcement action for individual senior managers and the FCA will publish an annual enforcement performance account. Since the SMCR has become effective for banks, the regulator has been monitoring its impact with a view to conducting a review of its effectiveness.
Based on his last two questions, the right reverend Prelate obviously has a sense of humour: he asked me to opine whether the new Prime Minister would effectively tear up the basis on which joint stock companies have been working for several hundred years and to comment on Brexit. Having been in post for about four weeks, I feel comfortable answering those questions. At the moment we will not change the principal duty but of course we will keep in mind that the regulators have a duty to maintain adequate financial resources and to take reasonable care to organise and control the affairs responsibly and effectively with adequate risk-management systems. On Brexit, we are determined that the industry and government work together to ensure that Britain takes full advantage of the opportunities. We want the best deal for financial services in Europe and outside and are aware of the implications of things such as passporting and equivalence; clearly, that will be part of the negotiations going forward. Work goes on to deliver those goals as we speak. Noble Lords will not be surprised to learn that after the Statement yesterday by the Prime Minister and the Leader, I will not go any further than that today.
The noble Lord, Lord Haskel, says that culture is not embedded. Of course the SMCR came into effect for banks only in March this year. Personally, I think a huge amount depends on the message from the top in organisations, but we are setting up the mechanisms and firms are taking them seriously.
Change will take time. The work of the Banking Standards Board and the FICC Market Standards Board will be key to raising standards. The Bank of International Settlements is making significant progress on a global code for foreign exchange, which is due to be published in May 2017. The noble Baroness, Lady Kramer, acknowledged that industry is responding well to the taskforce’s work on vulnerable people and things like that. I will come on to that in a minute.
The noble Baroness was honest enough to admit that she had lost the argument in this House about the reverse burden of proof. This was removed after long discussions involving some members of the banking commission, and I am not going to go over those again. I believe, as does the majority of Parliament, that the duty of responsibility is a better approach for embedding senior accountability across the financial services industry.
The noble Baroness also talked about the bonus gap. We did not support the bonus gap but for now it is in place and we have withdrawn the challenge to the EU. We want to build a system of pay in the global banking system that encourages rather than undermines responsibility.
The noble Baroness also talked about public sector organisations in helping vulnerable consumers. I agree that that is an important point—I will continue for a couple of minutes because I think we have until the hour. The CMA identified key groups of consumers who are not well served by the banking sector. No doubt the FCA will want to consider this alongside its high-cost short-term credit costs, and separately it is undertaking an extremely important piece of work on the needs of vulnerable customers.
The most reverend Primate talked about the leverage ratio set at 3% rather than 4%. One of the recommendations was to take this decision away from the Government, so we have left it to the FPC. That includes powers to set an additional leverage buffer to be applied to the systemically important firms that will supplement the minimum requirements if they so feel. It is an important point that this be left to the FPC.
There are some more questions that I have not spoken fast enough to get to, so I will write to noble Lords to answer the questions that I have not answered today. To summarise, we believe that huge progress has been made but also that industry is stepping up to the challenge. We know that momentum, once generated, must not be lost. That is why it is crucial that this vital industry learns from the mistakes of the past and moves on from them to earn the trust of the public once again.