Bank Resolution (Recapitalisation) Bill [HL]

Lord Sikka Excerpts

2nd reading
Tuesday 30th July 2024 Lords Chamber

[Lord Sikka (Lab)]

My Lords, when you are the last speaker in the queue, you find that all the good points have already been made and you have to rewrite your speech rapidly. I have a number of questions for the Minister. First, this Bill suspends the iron law of capitalism, which is that the inefficient and incompetent go to the wall. Somehow that is not to be applied to the banking sector. If the Minister considers the provisions of the Bill to be good enough for a flourishing finance industry, why not apply them to other sectors where we have many essential businesses?

Looking at the Bill, it seems to assume that the Financial Services Compensation Scheme—the FSCS— has significant reserves from which the Bank of England could immediately obtain benefits. Will the Minister explain what kind of reserves the FSCS is required to maintain and how their adequacy is judged? Its accounts for the year to 31 March 2023 show it had a surplus of just £5 million, which was then taken to cover the deficit of the pension scheme. In other words, there was a zero surplus for that year, but the cumulative cash balances were £510 million. Is that enough to rescue one or more banks or do these buffers need to be beefed up? I hope the Minister will be able to tell.

Bank failures could be localised or they could have a domino effect, in which case the FSCS would not have adequate resources. Will the Minister explain what would happen then? As I understand the Bill, insolvency would be the only option left. What have we learned about the insolvency of banks? The biggest insolvency was in July 1991 when the Bank of Credit and Commerce International was shut down, but to this day there has been no investigation, no report, nothing. What have we learned about insolvency of banks? Would the Minister like to reopen that probe and tell us why there has been no investigation, why there has been a complete cover-up and what we could have learned from it to devise better regulations?

Under the Bill, the cost of reckless practices at one bank would be borne by others, as the FSCS would raise levies on other banks. There are clear moral hazard issues here, especially as the boards of the failing banks do not face personal consequences and shareholders have only a short-term interest. Will the Minister explain how these moral hazards would be checked by the regime proposed?

We all know from history that rescue and recapitalisation is not the only way that the Bank of England and the Government rescue banks; they also engage in deceit, skulduggery and cover-up. The classic case relates to HSBC, which in 2012 was fined $1.9 billion by the US regulators for money laundering. At that time, it was the largest ever fine on a corporation. According to the US Department of Justice, HSBC

“accepted responsibility for its criminal conduct and that of its employees”.

The bank was regulated by the UK authorities, which took absolutely no action. In March 2013, the US House of Representatives Financial Services Committee began a review of the US Department of Justice’s decision not to prosecute HSBC or any of its employees or executives for admitted criminal activities. Its July 2016 report titled Too Big to Jail contained a two-page letter from the then Chancellor, George Osborne, and extracts of correspondence with the Financial Services Authority and the Bank of England. The Chancellor’s letter, dated 10 September 2012, urged the US authorities to go easy on HSBC as it was too big to fail. It also urged the US authorities to go easy on Standard Chartered Bank, which was fined £330 million for money laundering and for sanctions busting. Despite requests, which I have made in this House, no statement has ever been made to Parliament.

No documents have been placed on public record to show why banks are being rescued by deceit and cover-up, and this inevitably emboldens banks. In 2019, Standard Chartered was again fined for money laundering and sanctions busting—this time for $1.1 billion—and HSBC has been a habitual offender. Can the Minister explain why these matters are not being looked at? The institutionalised corruption increases the likelihood of banking failures. It would be helpful to know what steps the Government will take to cleanse the City of London. Simply saying “We will recapitalise banks” will not do.

The Bill rests on very shaky regulatory foundations. After the 2007-08 crash, the regulators’ duty to promote the industry was abolished and they were primarily required to be what I call watchdogs and guide dogs. The last Government changed that legislation and now regulators are required to promote competitiveness and growth of the industry. The regulators have effectively become puppies and lapdogs of the industry. Regulatory actions requiring stringent oversight or lower gearing ratios could be interpreted as a tax on competitiveness and the potential growth of the industry. Such conflicts were considered to be contributory factors in the 2007-08 crash, but they are now back on the statute books.

Lehman Brothers had a leverage of 30.7:1 when it crashed and Bear Stearns had a leverage of 36.1. On the one hand, the Bank of England and regulators tell the banks that they must be well capitalised; on the other hand, tax relief is offered on interest payments on the debt. Government incentivise taking on leverage. How can that create stability? Why do the Government not abolish the tax relief on interest payments by corporations? That would certainly reduce their financial risks and vulnerability. Again, I look forward to hearing from the Minister.

The current regulatory environment is much weaker than the pre-crash environment. Shadow banks are the new elephant in the room. Shadow banks include hedge funds and private equity, and all are unregulated. They are meshed with the retail and investment banks, insurance companies and pension funds but remain unregulated and totally opaque. Some parts of this industry are located in offshore tax havens, and it is impossible to see their financial statements and make any meaningful assessment of the risks and dangers that they pose to the banking system.

Private equity and hedge funds function as banks, but they are not subject to any minimum capital requirements, control on leverage or stress tests, even though the collapse of one firm can destabilise the whole sector. The collapse of the US-based Archegos Capital Management showed how rapidly the domino effects occur and had immediate negative effects on the capital buffers of Goldman Sachs, Morgan Stanley, UBS and Credit Suisse. Banks that are regulated in the UK now have multiple connections with shadow banks, including lending to buyout companies and the funds that acquire them, the firms that manage them and the investors that back them. There is a complex web that is impossible to penetrate, and that will ultimately bring forward a crash. In April this year, a Bank of England official responsible for financial stability, strategy and risk said that there were serious

“questions about the risks of these financing arrangements, and the growth in kinds and quantity of leverage, or ‘leverage on leverage’, throughout the ecosystem”.

Successive Governments have failed to bring shadow banks within the scope of regulation. A deeper crisis is being incubated, just as it was before the last crash. When the next crash comes—and it will come—it will engulf every sector of the economy, as private equity is into supermarkets, hospitals, GP surgeries, water, care homes, cosmetics, housing, property, hotels, insurance and everything else. There will not be enough money to rescue, so we need to strengthen the regulatory system now. The recapitalisation regime of this Bill will not be able to cope.

Of course, Ministers can dismiss the kinds of concerns that I have expressed, but it would be most unfortunate if the next crash was to come during the term of the Labour Government in office. Does the Minister know how many entities regulated by the FCA are enmeshed with shadow banks and what their risk exposure is? I have been unable to work that out by looking at the accounts of these organisations, but the Minister may have superior information. If he does have it, can I ask him to publish that data?

Shadow banking is now a major danger to the stability of the financial system and its practices can undermine the regulated banks, but shadow banks are not required to contribute to the recapitalisation fund. Why is it that they can create risks for the entire system but do not bear the cost? Can the Minister explain how much they will contribute to this recapitalisation fund and whether he considers their contribution to be adequate?

Bank Resolution (Recapitalisation) Bill [HL]

Lord Sikka Excerpts

Committee stage
Thursday 5th September 2024 Grand Committee

Moved by

[Lord Sikka]

9: Clause 1, page 1, line 22, at end insert—
“(3A) Before exercising the power in subsection (1), the Bank and the scheme manager must assess whether they consider that there should be a clawback of executive pay and bonuses from the previous 12 months.”Member’s explanatory statement
This amendment seeks to address potential moral hazards through requiring the Bank and scheme manager to take directors’ pay and bonuses into consideration when a recapitalisation payment is made.

[Lord Sikka (Lab)]

My Lords, Amendment 9 deals with moral hazards, which, if anything, are multiplying. The amendment seeks to restrain excessive risk-taking by imposing possible personal penalties on bank directors.

The recent legal developments have actually multiplied financial moral hazards and the related risks. For example, the Financial Services and Markets Act 2023 reintroduced the secondary regulatory objective to promote the growth and international competitiveness of the finance industry. In effect, it dilutes the regulator’s remit to protect customers. On 12 August, the Chancellor said that she and the Economic Secretary to the Treasury were constantly asking regulators, “What are you doing in practice to meet that secondary objective?” The meeting of that secondary objective will necessarily increase moral hazards.

Secondly, further deregulation is coming in—reforms of Solvency II, for example—with the claim that this will somehow conjure up an additional £100 billion of investment by reducing capital requirements. There is no pot of gold sitting in a corner in any bank boardroom that people can simply empty and get £100 billion out of. All of that is underpinning bank resilience and insurance company resilience. All of that is invested in some safety buffers. All of that will have to be liquidated. Yet the consequences for how the directors might behave have not really been outlined.

The cap on bankers’ bonuses has been lifted, so there are now economic incentives for bank directors to be reckless and take excessive risks, as that would maximise executive pay and bonuses—all done in the full knowledge that the bank would be rescued, restructured, recapitalised or bailed out, be it through the mechanism of the Financial Services Compensation Scheme or, eventually, some reconstruction. There are no great pressure points on bank directors to be risk-averse and prudent or to act in a responsible manner.

The risk-boosting effects of moral hazards are ignored by this Bill, yet they are highly relevant to any form of stability. We have a whole history showing how this happens. In the 2007-08 banking crash, attention was drawn to moral hazards or conflicts of interest between the interests of shareholders and managers, debt holders and the public purse. Bank directors took on excessive leverage because the state incentivised them to do so. It continues to incentivise them to do so, for example by giving tax relief on interest payments, which reduces both the cost of debt and the weighted average cost of capital while increasing shareholder returns, providing a justification for greater executive bonuses and remuneration.

Numerous studies have shown that shareholders were, and remain, focused on short-term returns. In any case, they still do not get good-enough information to invigilate directors; perhaps at some point, when we are discussing the world of accounting, I will point out how almost useless company accounts are in enabling shareholders or anybody else to invigilate directors. Back at the time of the last crash, directors accepted excessive risks from not only financing the organisation but risky investments. For example, numerous varieties of derivatives and complex financial bets were made because of explicit guarantees about depositor protection, central banks providing liquidity and support, and, ultimately, publicly funded bailouts.

If the bets made with other people’s money paid off, directors got mega payoffs; if they did not, somebody else picked up the loss, leading ultimately to rescue bailouts—now we are using the term “recapitalisation”. This Bill adds another string to publicly funded bailouts—though it likes to use different language. Yes, the cost of the FSCS levies is borne ultimately by the people, as has already been pointed out, and not necessarily by other banks.

If the Government succeed in persuading the banks to lend more to facilitate additional investment, as they are trying to do, that will add to the risks and strain the capital adequacy requirements of those banks. In boom times, banks tend to lend more freely, because they do not want to miss out on the opportunity to make more profits, and they relax credit standards, but there are inevitably consequences, as we saw with the last crash. Directors are rarely held personally liable, and that remains the position today.

Amendment 9 would address this gap by requiring the Bank of England and the scheme managers to consider a clawback of directors’ pay and bonuses paid during the previous 12 months. In case the Minister might refer to other clawback arrangements, let me pre-empt those. Paragraph 37 of the UK Corporate Governance Code states:

“Remuneration schemes … should include … provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so”.


That is of no help whatever, because such codes do not apply to large private companies, of which Wyelands Bank, which came to an end recently, is a good example. The codes are also voluntary and cannot be enforced in the courts. They do not empower stakeholders in any way; they do not require the clawed-back amounts to be handed to regulators or to be used for recapitalisation of banks.

The FCA handbook also has a section on possible clawback, but it applies to what it calls “variable remuneration”, which is generally taken to mean bonuses. It states that in certain circumstances the clawed-back funds need to be handed back to the institution. This does not cover entire remuneration; it does not require that the clawed-back amounts be used for the recapitalisation and reconstitution of banks. So, in the interests of clarity and certainty, a statutory approach to clawbacks is needed, not a mishmash of voluntary arrangements. I beg to move.

[Lord Vaux of Harrowden (CB)]

My Lords, I shall speak to Amendment 16, which would do a certain amount of what the amendment from the noble Lord, Lord Sikka, would do, but in a slightly different way. It is intended as a probing amendment to obtain clarification on what ability there would be to recover all or some of the costs of failure from either management or shareholders of the failed entity when it is recapitalised rather than being put into insolvency—there seem to be two different things there.

It is possible to imagine a situation where members of the management team responsible for the failure are paid large bonuses or dividends prior to that failure. As the noble Lord, Lord Sikka, pointed out, that is more possible now that the cap on bonuses has—rightly, in my view—been lifted. Can the Minister clarify in what circumstances it would be possible to recoup those bonuses or dividends to offset the recapitalisation costs? In an insolvency situation, where there is fault—for example, in cases of wrongful trading—it may be possible to recoup those payments, but I cannot see how that would work if the bank was recapitalised. To me, it must make sense that management should not see the risk of having to repay bonuses or dividends as being lower than it would have been if the bank had been put into insolvency just because the bank has been recapitalised.

--- Later in debate ---

[Lord Livermore (Lab)]

I have managed to get through several groups without promising to write, but on this occasion I will write to the noble Lord.

[Lord Sikka (Lab)]

I thank the Minister for his reply. I will divert slightly to the point made about dividends. The legislation is a complete mess on distributable dividends. The previous Government were going to table legislation about some disclosures of distributable reserves, then just a day before—without any notice to Parliament—they withdrew that, because most companies do not have a clue what their distributable reserves are. This raises all sorts of questions about what are realised or unrealised profits. I will not go into the technicalities at the moment. Any time I hear a Minister talk about dividends or say, “We are going to control dividends”, whether it is about water companies or any others, that is just a no-go area at the moment. It cannot be sorted out without major primary legislation.

The Minister said that there is already legislation in place for civil criminal prosecution. I am afraid that legislation delivered hardly anything after the last banking crash. Countries such as Iceland and even Vietnam prosecuted far more bankers for their negligence than the UK did, though we managed to elevate some afterwards to some very senior political positions, so that legislation is not really effective. I take it from the Minister’s reply that he is not prepared to consider legislation specifically saying that there will be a clawback of executive remuneration. That is the point—in the absence of it, who knows whether the management concerned will bear any personal cost at all? Is my interpretation of the Minister’s reply correct?

[Lord Livermore (Lab)]

I do not have anything further to add to what I said.

[Lord Sikka (Lab)]

I thank the Minister. I withdraw my amendment for the time being, though I may bring it back at the next stage.

Amendment 9 withdrawn.