Financial Services Bill

My Lords, towards the end of a debate of this kind, most of the key issues have been identified and discussed by other noble Lords, but over the years I have had the advantage, if advantage it is, of looking at many of these questions from different points of view. In the 1970s, as head of the treasury department of a merchant bank, I used to report to the Bank of England, while in the 1990s I was a member of the board of the Financial Services Authority. Also, for a number of years I was chairman of the audit committee of an international bank. I find myself absolutely astonished, appalled and baffled by what has happened over the past two or three years and I have been trying to get to the bottom of it. I shall pick out just two or three of the key issues that we need to address. The first is who should take the lead in the critical area of supervision. This is not a matter for dogma or for personalities; it is a matter of practicality. The conclusion that I come to is that the Bank of England seems to be better situated to deal with these things than the FSA. There is a difference of style and culture between the two. The style of the FSA tends towards the legalistic. I am not at all surprised that it is now felt that the FSA in later years paid a disproportionate amount of attention to consumer issues at the expense of the supervisory side. That may have had an impact on its performance. The Bank of England has much greater practical experience of markets. Being close to and understanding the markets lies at the heart of the most difficult aspects of banking supervision. One can identify practical examples of where the Bank seemed to have got the message rather earlier and more thoroughly than the FSA. I do not want to run down the authority because I respect its chairman, just as I respect the Governor of the Bank of England. However, the FSA was more detached from the market system, which you need to know about if you are going to be an effective supervisor. If the idea is to have one authority embracing these functions, it should probably be the Bank of England and not the FSA. I am encouraged by what has been said by the noble Lord, Lord Turner, about the supervisory enhancement programme—rather a typical title for what is really an executive and administrative exercise—but I very much agree with my noble friend Lord Blackwell that there is confusion in many people’s minds between regulation and supervision. Regulation is about making rules and setting up a structure in which the regulated bodies have to conduct their business. Supervision is a question of micro-prudential issues, institution by institution. That requires a very different cast of mind. The central problem of the crisis of the past two or three years is that things were being done by a large number of substantial institutions in many countries that, when aggregated, produced a global financial crisis. But nobody seems to have been looking at them closely enough to see the macro side as well as the micro that was in front of them and at which they were meant to be looking. I constantly scratch my head and try to work out what sort of reaction to these dangerous activities was felt inside the institutions and by their auditors. There were the operatives who implemented the policies of taking on what would become toxic assets and dealing with complicated derivatives. There were the management and board of those institutions. There were the internal audit department, the audit committee, the external auditors and the supervisors. Everybody got it wrong. If I am not out of order to quote Her Majesty, she got it absolutely right with her killer question when she went the LSE. She asked: ""If these things were so large, how come everyone missed them?"." It is a question that needs an answer. I do not know how, on such an enormously wide and varied scale, the principal financial bodies could really have missed everything. Were they not looking or were they looking in the wrong direction? We need to know more in detail how these things came about. If you have a problem, you need to know what has gone wrong in detail and why before you can put it right. I hope that the measures in the Bill will contribute to a much sounder system in future, but that will depend on people asking the right questions and, on past form, one cannot be 100 per cent confident that that will happen. There has been a tendency to use mathematical models to measure risk. Such models have their use but they are only as good as the assumptions that you feed into them. More and more it seems as though some of those mathematical models were rather off beam. The Governor of the Bank of England, at least two years before the Northern Rock crisis, issued a warning that he felt that the markets were mispricing risk. They were indeed. It took a while for that to become evident, but I do not think that anything happened at the FSA end. I do not think that the FSA asked of every institution that it was supervising, "What does the governor’s remark mean in this case? Have we looked at the areas where things could be mispriced that would cause danger to the institution itself?". We still have a whole raft of unanswered questions and, at the outset of consideration of a Bill such as this, we have to face the fact that there is still a lot that we do not know that we need to know. My noble friends Lord Lawson and Lord Blackwell and the noble Lord, Lord Barnett, mentioned the separation of different kinds of banking. I have tried to work out how you would do that in practice and how you could have an effective firewall between the two. My noble friend Lord Blackwell said that you could have two separate incorporated bodies as subsidiaries of the same parent. In theory, that might work, but, in practice, you would have two bodies performing very different types of business but where the capital and implicit guarantee of the funds of the body were separated from an area where business was being done on an entirely different basis. It might work, it might not, but it is an important point and should be looked into further. Many of the problems of the past few years have come through having monetary policy too loose for a long period. It is not just the property bubble; there were other areas, which I will not say more about now. We should not lose sight of the fact that the tremendous pressure on the acquisition of assets came from surplus funds in the system. That casts doubt on whether the consumer price index can really carry on on its own as the important point of reference.