Eurozone Crisis

My Lords, I, too, congratulate the noble Lord, Lord Lamont of Lerwick, not only on securing the debate but on an excellent introductory speech. I also add my words of congratulation to the noble Lord, Lord Wolfson of Aspley Guise. We have waited a long time for his maiden speech but it has been well worth it. We look forward to his future contributions to our debates. I was due to speak immediately after the noble Lord, Lord James of Blackheath. He is with us in Grand Committee but is not going to speak. I am disappointed because he would have made a contribution of national significance to this debate. I propose to confine my remarks to the European dimension of the Motion. The Minister has had more than enough excitement, pushed by me to the point of agitation this week on the Autumn Statement, and I do not want to put him at risk of again losing his self-control. I shall limit my remarks to Europe. The key in Europe now lies with Germany. It seeks to promote a transfer union linked to fiscal contracts—real and enforceable. Germany can move only at the pace that the German people will agree with. I am sure that the noble Lord, Lord Lamont, would have used the word ““democratic”” in talking about the limitations to what Angela Merkel can currently do. The German proposals will be accompanied by measures ultimately to bring productivity costs across Europe into a more harmonised relationship than they currently have, and only Germany can legitimise the ECB if it moves to take less conventional policy stances. In that respect, I particularly welcome today’s cut in interest rates by the ECB. There is more that it can do within conventional mechanisms before it needs to consider doing the unconventional. I also hold very firmly to the view that there are right and proper limits to what a central bank can do. Those apply to the ECB, as they do to any other central bank, and they are eloquently summarised in Walter Bagehot’s Lombard Street, published in 1873, which is as relevant today as it was then. Germany’s plan, as I said, is the implementation of structural reforms by obliging nations to pursue or steer economic strategies. This is a very difficult call, as our current Chancellor is finding out. It is not easy, and I would be the first to admit that this is a judgment that I do not feel confident in making. I do not think any economist or Minister could be confident in making that call about whether you think debt is frustrating growth, which is clearly the position that the Chancellor of the Exchequer is currently taking, or the position that the Labour Party is taking, which is that the growth problem is increasing debt. There is clearly a tipping point there somewhere, and it is extremely difficult to establish where it is. The Germans are also seeking to promote the European financial stability facility, which they want to see leveraged, and to provide a solid support for interventions that are necessary to help the eurozone through this difficult period. The EFSF is looking increasingly stretched; global funding support is clearly not available and there is nervousness about the lack of transparency and use of leverage. The increased slippage in the ratings of a number of European countries means that the burden of AAA support for the EFSF is increasingly dependent on Germany, which means that the size of the EFSF, even complemented by the available funds from the IMF, is probably not sufficient to meet the financing needs of Europe over the next three years. This is a very serious issue, which does not rest solely at the door of our one Treasury but is a matter on which it should take an active involvement in discussing. There Germans are also seeking to secure a treaty committing eurozone nations to long-term budgetary discipline. There has been much talk about the ECB, either directly or via loans through the IMF and the EFSF, supporting Europe. But this primarily addresses the problem of liquidity. There is a liquidity problem, and it is very worrying to see the almost complete attrition of issuing of unsecured bonds by banks over the past six months. The funding of banks is now becoming as difficult as it felt during the second and third quarters of 2008. Money market funds are withdrawing support for European banks—not British banks, but European banks. This is a moment of increasing nervousness. Europe needs without delay to significantly strengthen the capitalisation of its banks and banking system to absorb the inevitable losses that will come forward as a result of the write-offs of sovereign loans, while maintaining depositor and counterparty confidence. The EU bank capital objectives announced last month by the EBA simply fail on three critical tests. They were too little; €106 billion is simply not enough. The IMF estimated the need for at least double that; my own personal view is that it would be more than treble that amount to get the banks to a position where people can say that is more than enough to cope with whatever might hit these banks in terms of write-offs. That is what we learnt in 2008; you need to go further than your advisers tell you to ensure that you have absolute comfort and security. Secondly, the EBA’s proposal is too slow; it allows the banks until June 2012. We should do that as a matter of urgency, and if banks cannot raise capital from their own shareholders they should raise it from their national Governments and if they cannot raise it from their national Governments they will have to raise it from European institutions or the IMF. The third fatal flaw in the EBA’s proposal is that it is expressed in terms of ratios of capital to risk-weighted assets. So banks are naturally contracting their lending to achieve the ratio target, which can be addressed only by putting an absolute capital requirement in place to ensure that banks do not use that strategy. We are already seeing that happen with UK banks, which is one reason why the Chancellor had to increase the rate at which the bank levy is charged, because banks are contracting their balance sheet, as the Governor of the Bank of England has also talked about. So that needs to be done as a matter of priority. The Bank of England has made it clear today that it believes that more can and should be done by our banks to increase their capital. Our banks are relatively well capitalised, but in my experience no bank can have too much capital in these sorts of markets. But banks do not cover their cost of capital, so it is very difficult for them to raise money from the markets. How can they address this? They have to cut back on dividends—very few of them are paying dividends, but those that are should not. They also need to stop paying bonuses. It is an absolute nonsense that an industry which cannot cover its cost of capital still pays huge bonuses. Why can this be? They have said that they have to remain competitive to protect the interests of their shareholders. However, the same shareholders own all the banks. Institutions such as BlackRock, Capital International, Fidelity and Legal and General own shares in almost all the banks. I encourage the Minister and the Treasury to take immediate action, to call these major institutions in and say to them, ““We want you to write to these banks and say that, across the board, you expect them to adopt a wholly different approach to bank bonuses””. That would be a powerful forcing mechanism which would stop the excuse that they have to pay bonuses to remain competitive. It would also take a lot of the heat off the Government, who bear a lot of criticism for bank bonuses, but, from my own experience, are quite limited in what they can actually do. I encourage the Minister to take strong and robust action on that point. The Minister should also back up the Bank of England’s suggestion today that the FSA should intervene to ensure that banks do not contract their balance sheets. The Bank of England’s Financial Stability Report is very clear that something needs to be done here. The Treasury needs to say to the FSA, ““What are you going to do in response to the governor’s report today?””. Finally, I encourage the Bank to do its very best, as we did when I was in Government, to support the interests of Britain in Brussels and protect the important financial sector within our economy.