John Redwood’s contribution to the Banking Bill debate

Mr. John Redwood (Wokingham) (Con): I welcome a Bill on this subject, and I am glad that my right hon. and hon. Friends on the Front Bench are in a collaborative spirit because this is a case where working together might improve the Bill, but it needs a lot of improvement because the main things that have gone wrong in the past 11 years stem from the grave weakening of the Bank of England that occurred in 1997.

I would like the Bill to go much further than the current draft in giving back to the Bank of England the powers that it had before 1997. I would like the Bill to make it clear that the Bank of England needs to see and understand all of the business in the money markets. The Bank needs to have powers and duties so that it is the prime driver of the money markets. I would like to see the Bank have those powers back so that it is a better judge of the amount of cash and liquidity that we need in the system at any given time, and so that it is more able to enforce its interest rates in the marketplace, which it has been unable to do during the recent, extraordinary breakdown of the markets.

Like my hon. Friend the Member for Stratford-on-Avon (Mr. Maples) and others, I believe that this is not just a story of big banking error—although it is clearly such a story—but a story of massive regulatory failure. I would highlight three regulatory failures, in a different way from my hon. Friends so as not to bore Members or repeat things that have already been stated. The first failure is the regulatory failure of the Monetary Policy Committee of the Bank of England. In the early part of the decade, the committee kept interest rates far too low. It seemed unaware of the power of low interest rates to drive ever more credit, lending and borrowing in the system, and it ignored all the warning signs in the asset markets and the credit bubble that was emerging in the banking figures. Worse than that, the committee is now making exactly the same mistake in reverse. Now that there is a need to fight the problem of recession and deflation, the MPC is driving the car by looking in the rear-view mirror. It is shocked at how much inflation has got out of control, so it is keeping interest rates far too high for current conditions, and way out of line with those in the United States of America, for example.

David Taylor (North-West Leicestershire) (Lab/Co-op): The right hon. Gentleman talked about restoring powers to the Bank of England. Is he about to make the point that monetary policy decisions on interest rates should be taken away from it, almost as a quid pro quo? In the example that he gave of interest rates being set far too low in the early years of this Government, to which I infer he refers, surely the Bank was in pursuit of the target that it was given by the Chancellor of the Exchequer on inflation.

Mr. Redwood: It clearly was not because the target was to keep inflation to 2 per cent. Inflation is currently 5 per cent., so it is 150 per cent. over the target. I am afraid we have to judge that the MPC got it comprehensively
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wrong. I am not suggesting taking the ability away, or putting the matter back under ministerial control; I am making a plea for a much stronger Bank of England that sees all the market activity and Government debt, which was taken away from it and nationalised into the Treasury, and which sees all the day-to-day transactions of the banks because it is regulating them. It would then understand the money markets, and if bankers, alongside academic economists, were trying to produce a total package on how we intervene, how much money we supply and at what price we supply money, the institution would have a better chance of making those independent judgments in the interests of the whole economy. I do not think that anyone in this House can allege that the MPC has been a success because inflation stands at two and a half times the target, the money markets are in meltdown, and interest rates are now far too high for most borrowers. That increases the likelihood of default on loans and further undermines the asset base of the banking system, which is in a very fragile condition.

The second set of errors that were made by the regulators relate to money market liquidity. Perhaps things were too integrated on this occasion, but in the early part of the decade the Bank of England reinforced the message of the MPC by making large amounts of cash available—the markets were too liquid. More recently, the Bank started to withdraw liquidity and every time it did so in 2007, and even in 2008, it exposed more financial institutions to difficult pressures, which we have seen bubble up from time to time. The lesson has been learned there, and while I regard the MPC as still making the same old mistakes, the Bank is now doing exactly the right thing, with Government help, by making huge amounts of liquidity available. There have been statements that it intends to carry on doing so while the fragility continues, and I am pleased we have got to that point, but if we look at the record of the previous seven years, we see—because the Bank did not have the knowledge and powers it used to have—that it was too easy in the easy times and that it withdrew too much liquidity at times of stress and difficulty.

The third set of problems has arisen in the way that banking capital and banking caution have been regulated, as my right hon. and learned Friend the Member for Rushcliffe (Mr. Clarke) and my hon. Friend the Member for Stratford-on-Avon said. There is no doubt that, again, we had pro-cyclical regulation. In the easy money times, the regulator did not seem too worried about banking capital and the gearing. Indeed, we saw the gearing of institutions massively increase over the levels of the ’80s and ’90s. I am afraid that those Members who say that such problems date back to the ’80s do not understand the situation. The gearing in banks is far higher today than it was allowed to be under the system in the ’80s and ’90s.

Now we see, at this rather late stage, the regulatory pressures towards having more banking capital relative to the stock of debt, at exactly the point where the system is extremely fragile. I urge the Government to be careful not to go in for more pro-cyclical regulation, so that they do not increase the deflationary forces at exactly the wrong time, just as the regulatory system seemed to increase the inflationary forces during the days when money was far too easy.

I would like the Bank of England to be reconnected, by being the agent for Government debt, by being the
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supervisor of the banks, so that it sees all the money market transactions, and by being given more opportunity to manage not just the price but the quantity of money, so that we can have a smoother progression. We have lurched from boom to bust and from unacceptably high inflation to what I think will prove to be a lot of disinflation, as we see the impact of the credit implosion come through in prices.

When I was first invited into government, I was given the job of insurance regulator for the then Secretary of State for Trade and Industry. The two main duties of the insurance regulator, which was then a ministerial role, were to ensure that the insurance companies were solvent and to ensure that they were run by fit and proper people. That regime was rather similar to the kind of regime that applies in broad outline to banks and it was perfectly sensible. Coming from a financial background, I had a great fear that conditions would get tough in the early ’90s and that there could be a casualty or two in the list, so I asked for proper information from my regulatory team. It took me a little while to get it in the form that I wanted, but we had the powers to procure it.

Once I had on my desk the balance sheet and the profit-and-loss risk, as we saw it, of those institutions, I managed it. If I saw an institution that I thought might be short of cash or in some other difficulty in six months or a year, I would get on the phone to the chairman of that company privately and say, “I am your friendly regulator. I do not have a power to instruct you to raise money, but it seems to me that it would be very helpful if you did raise some money.” In each case the chairman was very obliging and said, “Actually, it’s a good idea,” or, “Yes, we’re going to do it.” In each case they raised money and those institutions got through what was a fairly unpleasant insurance downturn with no problem.

It is not that difficult for a regulator to do that, because they have access to the information, but it is most important to follow this fundamental principle: they must always act in private. They must never name the institution or seek any credit at the time, because we are talking about incredibly price-sensitive information. If any wind or whiff gets out of the office that the regulator has even a scintilla of doubt about an institution, there could be a run on it and a lot of negative journalism about it. The regulator’s task will then be 10 times greater, because the institution will be on the slippery slope downwards and it will be damaged.

I therefore urge the Government to ensure that there are no leaks or running commentary to us and the public as such difficult and sensitive discussions are under way. Those occasions are ones when it is best if things are done in private and as speedily as possible, and if we are told only when the decision has been made and the proper authorities can be notified.
Apart from greater powers for the Bank and whatever powers the regulator needs to regulate intelligently in the way that I have described, I would also like to see some kind of control in the Bill of the ability of the Government and the Bank to use the special powers of acquisition. I strongly believe that in practically every case, if not in every case, it should be possible to solve such problems with private sector solutions, such as
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through private sector fundraising or by cancelling the dividend, cutting costs, shedding some assets, having some disposals or ensuring that capital can be found from sources outside over a reasonable time period.

Those are some of the panoply of ways a business can try to get its capital ratios into shape and get the cash that it needs to continue its business. It should be in the interests of all well-meaning people in the House to keep those things in the private sector, to make businesses accept the disciplines of the private sector, to blame those in charge of them when they get it wrong and to ensure that the new management sort things out as quickly as possible.

However, my worry about the proposals before us is that the taxpayer is being asked to take on too much risk. The three banks to which public capital might be subscribed—I say “might” because a number of votes have to take place and there are still opportunities for private shareholders to come forward with money—have, in aggregate, balance sheets of almost £3 trillion. That is twice the country’s national income and around five times its annual tax revenue. If something went wrong and just 1 per cent. of those assets had to be written off, the owners of those banks would collectively lose £30 billion.

Thirty billion pounds is a very large sum of money, even for the British taxpayer. It is 5 per cent. of tax revenue in a single year. Are we sure that there could not be a 1 per cent. loss on the assets of those banks when they come into public ownership? I know that some of those assets are as risk free as one can get, and include Treasury bills and that sort of thing, but some of them are not. Some of them are the mortgages and the loans to companies that we have been worrying about. We are being asked to absorb those assets as we go into recession, when it will not be just the mortgage book that deteriorates in quality, but the loan book to companies, as I fear that we are about to enter a period when companies will find it difficult to keep going. In some cases they will find it difficult to earn a profit or generate cash and will look to their bankers for more support. In some cases, businesses will stumble and be incapable of keeping the payments going.

I would therefore like a reminder in the legislation, and perhaps a requirement to come back to the House in an emergency, that there must be some limit. Just as we are now preaching to the private sector that banks should not get over-geared and over-borrowed, should we not be preaching to ourselves that the Government and the public sector should not get too over-borrowed and over-extended? I hope that the Government will go away over the next two or three weeks, work with those banks that have given an indication that they might like public capital, go through the figures again and ask, “How can you get the demand down? How can you generate more cash for yourself? How can you get more private sector capital coming into your bank to cut the taxpayer risk?” Otherwise, the British state will be left in a weakened condition, which is not what we want at this juncture.

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One Comment

  1. mikestallard
    Posted October 20, 2008 at 9:13 pm | Permalink

    An excellent – and surprisingly astute and realistic statement, if I may say so!
    Two questions:
    1. Wouldn't you have liked to have made this excellent speech a couple of months ago when parliament was still on holiday?
    2. I have not seen this on the parliament channel. How many people were there to listen to this speech? And, just as important, how many were prepared to do anything about your excellent analysis and advice?

    Reply: Thank you. Yes I did want to make the speech earlier, and did call for Parliament to come back in September so we could discuss how to handle the crisis. The BBC would not run a speech like this as it does not conform to their caricatures of me which they take from Labour spin.All they can do is drag me into a studio to blame me for the crisis for being a deregulator, without having read my Report and other pieces which set out how we needed to regulate banking capital, liquidity and interest rates better!

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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