08 July 2009
Reforming financial markets
Check against delivery
Mr Speaker, with permission, I would like to make a statement on the Government’s proposals for reforming financial markets.
Copies of the document are available in the Vote Office.
The world economy has been hit by a severe financial crisis, resulting in the worst economic downturn for well over 60 years.
Its origins lie in failures in the banking system around the world.
Financial institutions in many countries took on too much risk. They became over-reliant on wholesale funding, too exposed to particular products. And irresponsible pay practices made banks take unnecessary risks.
It is also clear that some financial institutions had little appreciation of what was going on inside their businesses.
But regulators and governments too must learn from the events of the last two years – better understanding the risks that come from rapid globalisation in the financial system.
Mr Speaker, our economy has a clear need for well managed, well functioning banks and financial institutions – to perform a vital set of functions – channelling investment and helping people save and plan for the future.
The financial services industry is also a major employer, of over one million people, and will continue to generate wealth for our country.
Our central objective must be to ensure that – as we come through the downturn – we reform and strengthen our financial system and rebuild it for the future.
With consumers that are better informed, financial institutions that are better managed, and markets that are better regulated.
The proposals I will set out today build on our previous reforms to provide a new settlement that –
- Is open, competitive and effective – able to meet the needs of business and families;
- Inspires trust and confidence on the part of businesses and consumers;
- Ensures robust regulation that reduces the likelihood of failures, without preventing innovation;
- And provides effective mechanisms for dealing with the failure of financial institutions if they do occur.
Mr Speaker, I want to take steps to help consumers make better informed choices.
To ensure they are given access to free impartial financial advice, we will legislate to introduce a national money guidance service and impose a levy on the financial sector to help fund it.
We will also legislate to consolidate existing FSA resources to provide separate independent consumer education, setting up a lead provider of consumer information and personal finance education.
Consumers will also get more protection, along with greater right of redress and access to compensation if things go wrong.
We will also improve arrangements for depositor protection, including legislation to pre-fund and expand the role of the Financial Services Compensation Scheme.
Mr Speaker, because of the events of the last two years, there are currently fewer firms in the market providing financial services.
It is essential we retain competitive markets – as they play a key role in providing consumers with value and choice.
We want to see greater competition and greater choice for consumers – as well as a bigger role for mutuals and building societies.
So the OFT and the FSA will ensure that we maintain competition in the market for financial services – as we come out of this downturn we need to promote a competitive market than enables new entrants, which may include non-banking institutions, and innovation to benefit consumers and businesses.
This way, we will see better informed consumers, who have greater choices, in a more competitive market.
Mr Speaker, we also need banks and financial institutions that are better managed.
We need a change of culture in the banks and their boardrooms, with pay practices that are focused on long-term stability and not short-term profit.
The FSA now has powers to penalise banks if their pay policies create unnecessary risk, and are not focused on the long-term strength of their institutions.
And from now on, I will require the FSA to report, every year, on how financial institutions are complying with their new Code of Practice for remuneration, and how they will deal with firms that don’t comply.
Bank boards and institutional investors must also become better equipped to do the job and understand their businesses, with more effective risk management and greater independence of non-executives – who must not be afraid to ask searching questions.
And next week Sir David Walker will report on measures that will deliver improved corporate governance at financial institutions – ahead of his final report in the autumn.
Mr Speaker, building on reforms already made, my proposals today will strengthen regulation of the financial system.
They will cover three areas:
- First, new regulatory powers, to allow tougher regulation of individual firms;
- Second, measures to deal with the potential failure of institutions that could have a significant impact on the economy;
- Third, a strengthened framework for financial stability, to deal with system-wide risks in today’s more complex and global markets.
We will continue to work with other countries to deal with what is, at heart, a global problem.
Mr Speaker, I asked Lord Turner to make recommendations, which the FSA are now implementing, to strengthen the regulatory regime and increase the intensity of supervision. They will:
- Strengthen rules to ensure banks hold enough capital as a buffer against losses;
- Introduce a backstop power ensuring banks do not overextend themselves, lending too much when they don’t have the strength to do so;
- And increase the focus on bank liquidity, so they are able to carry out their business at all times.
These measures will help ensure financial firms that are stronger, more resilient, and better able to serve the needs of our economy.
I will also introduce legislation in the autumn, to give the FSA a new statutory objective for financial stability, and extend their powers to ensure they:
- Have the appropriate rules to deal with different risks in individual banks;
- Have tougher powers and penalties against misconduct;
- And take account of new developments in the financial sector – including expanding regulation where necessary – for example systemically important hedge funds.
Mr Speaker, we need to ensure our resolution regime can deal with financial institutions of all sizes, including banks that are very large or complex.
Because these banks are often global, we also need an international mechanism for resolving large multinational banks – and we will be bringing forward proposals to the G20 finance ministers when they meet in London in the autumn.
At home, we can better deal with these risks by ensuring safeguards are in place – for example by making banks hold capital at a higher level that reflects not only the possibility, but also the cost of failure.
By introducing higher standards and transparency, the FSA can also improve the functioning of key markets, such as the derivatives market – so that problems in one institution are less likely to spread through the entire system.
And the FSA and the Bank of England will make institutions put in place practical resolution plans which can be deployed in the event they get into difficulties.
There is, of course, a debate about whether governments should restrict the size of banks or separate different types of banking – as happened in the US in the 1930s.
I believe this is a simplistic solution, and fails to take into account the complexity of today’s financial system.
It is not only large banks, but small ones too, that can threaten financial stability – as in the case of Northern Rock.
Equally, both retail and investment banks, in different parts of the world, have failed in the past year.
And it is not only banks that can affect stability – as we saw with the American insurance company AIG.
In addition, the approach of having one regulator for one category of institution, deemed to be systemically important, and another regulator for the rest, misses the point.
What is systemically important can change rapidly, as we have seen in the last two years.
Rather the regulatory system has to recognise and respond to the complexities of individual institutions – and that is what we are doing.
Mr Speaker, we also need to strengthen the framework for financial stability.
This is not only a question of institutional powers and responsibilities, but also a question of better understanding of what is happening in the markets.
There are no simple fixes, no single institutional reform that could have prevented these problems occurring.
There are different institutional frameworks in countries across the world – but no one model has been successful in insulating a country from the current crisis.
Although regulatory arrangements were not the cause of the current problems, we do need the right institutions to maintain financial stability and also ensure they have the right tools to do the job.
The move here to a single regulator twelve years ago addressed problems with the previous regime of multiple self-regulators, which did not reflect the changing nature of financial markets – and has been adopted by many other countries.
Ten years on and the world has moved on again. Some of the global problems of the past two years went beyond the scope of existing regulation. Others were simply not given sufficient attention by regulators and central banks.
Here the authorities have been able, over the past year, to deal quickly and effectively with a number of financial stability issues – such as Dunfermline and Bradford & Bingley.
But further reform is now needed. So we will legislate to set up a new Council for Financial Stability – which will bring together the Bank of England, the FSA and the Treasury.
This will not just to deal with immediate issues, but also monitor system-wide financial stability and respond to long-term risks as they emerge. This needs to be done on a formal statutory basis.
The Council will draw on the expertise of the FSA and the Bank, who are and will remain independent of Government, by looking at their regular reports – the Financial Stability Report and Financial Risk Outlook – and formally responding to their recommendations.
That way when risks or threats to stability are identified they will be addressed.
It will do this in way that is transparent and accountable – so people can see how and why decisions are made – with regular publication of minutes.
And the Council’s responsibilities will be set out in law, with published terms of reference.
And, in discussion with the Treasury Select Committee and the House, we will consider how to increase accountability through greater Parliamentary scrutiny.
Mr Speaker, we have already taken significant steps to improve the way we monitor and manage risks to the financial system as a whole, for example through more systematic use of stress testing of financial institutions.
And my proposals today will further strengthen our ability to identify and deal with systemic risks, and ensure the authorities can be held to account for their actions.
We also need to consider what further counter-cyclical measures are needed, to allow us to lean against the credit cycle and prevent the build-up of risks that could threaten the stability of the financial system.
The principle of leaning against the cycle is easy to agree. Deciding what action to take, and when, is far more complex.
At the moment there is no clear consensus here or abroad. But I believe that central banks will have an important role to play in this area.
Today’s global market for finance means that new measures can only be effective if implemented on a broad international basis.
So under our presidency of the G20, we will continue to press for measures to strengthen the international regulatory architecture, building on the proposals agreed in April.
And in Europe, too, we will argue for enhanced monitoring of system-wide risks, while retaining the crucial link between national regulators and governments.
By working internationally, our efforts can help us deliver more effective supervision of global banks, stronger international standards, and a more responsible global financial services sector.
Mr Speaker, we intervened to stabilise the banking system, while retaining a clear view that banks are best managed and owned commercially and not by the Government.
We intend to return our stakes in the banks to the private sector, in a way that brings best value to the taxpayer, promotes competition, and maintains stability – and using the proceeds to cut government debt.
Mr Speaker, we are empowering consumers, supporting better corporate governance, and strengthening regulation.
So our financial sector can continue to be engine of prosperity.
And I commend this statement to the House.
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