Bank Resolution (Recapitalisation) Bill [HL]

Commons Amendments

15:41:00

Motion on Amendment 1

Moved by

That this House do agree with the Commons in their Amendment 1.

1: Clause 1, page 1, line 21, leave out subsection (3)

My Lords, with the leave of the House, I will also speak to Amendment 2. I would like to thank noble Lords for their continued interest and engagement in this important legislation. I know that some noble Lords will be disappointed to see the other place overturn the amendment inserted by your Lordships’ House, relating to the scope of the new mechanism, but I hope that I can offer some reassurance today on this matter. As noble Lords will know, this Bill is intended to enhance the toolkit that the Bank of England has to manage the failure of a banking institution. In particular, it seeks to provide a new source of funding to cover certain costs associated with resolution and, in doing so, to strengthen the protections for the taxpayer, given the importance of protecting public funds in the event that a bank fails. That said, I do understand the concerns that noble Lords have about any potential costs that would be placed on the banking sector if the Bill’s mechanism were used to support the resolution of some of the largest banks. Here, I would reiterate that it is the Government’s strong expectation that this mechanism would not be used to support the failure of the largest firms. Noble Lords will recall that the Government published draft updates to its code of practice in October last year, which contained important language clarifying this expectation. I also met with many noble Lords in person during the Bill’s passage to listen carefully to concerns and to seek to explain the Government’s views on this matter. Ultimately, the other place has taken the view that the scope of the mechanism should not be limited. The Government continue to believe that it is important to retain some flexibility for the Bank of England. I would like to make three further points to help explain that position. First, as I have mentioned, the Government published draft updates to the code of practice to clarify our expectation that the Bank of England would bail in all readily available MREL that a bank holds, on top of the regulatory capital that must be bailed in, before using this mechanism. The Government therefore envisage that the mechanism would only be used on larger banks as a backstop, and any funds required would be only a top up to these other sources of recapitalisation. Secondly, allowing the Bank of England the option of using the recapitalisation mechanism on larger banks means that it will be more able to respond to unexpected factors when resolving a bank. While of course the Bank of England works hard to ensure that it is fully prepared for a failure scenario, the manner in which banks fail is always highly uncertain. It is therefore important to ensure that the Bill is not overly restrictive in curtailing the Bank’s ability to use the mechanism flexibly. As we have discussed in previous debates, there are some circumstances where retaining that flexibility could help to protect public funds. Although unlikely, there are circumstances in which larger banks may not be sufficiently capitalised to self-insure against their own failure, even if the bank in question has been directed to maintain end-state MREL requirements. An example of that might be if the firm was subject to a large redress claim, resulting in larger recapitalisation requirements than envisaged. Similarly, changes in the market value of the firm’s assets over time could result in higher losses than expected at the point of failure, again resulting in higher recapitalisation requirements to manage the failure of the firm in question. While unlikely, those examples demonstrate a clear benefit in having the flexibility to source additional resources from the mechanism, having already written down the firm’s available MREL. Restricting the scope of the Bill would prevent the mechanism from being available in such scenarios, leaving public funds and therefore the taxpayer exposed instead. The Government therefore consider the theoretical possibility of using the recapitalisation mechanism on a larger bank a prudent step, providing comprehensive protection for public funds. Thirdly, any levying by the Financial Services Compensation Scheme to recover funds provided to the Bank of England will be subject to an affordability cap set by the Prudential Regulation Authority, which is currently £1.5 billion per year. In line with its safety and soundness objective, the PRA carefully considers the affordability of the FSCS levy for firms, providing an important safeguard against the sector being hit by unaffordable levies to prop up the largest firms. I hope those points will go some way to reassuring noble Lords, and that they will be able to support the Bill as it now stands. Noble Lords will note that Amendment 2 is a straightforward amendment to remove the financial privilege amendment that was inserted by this House at Third Reading. I beg to move.

My Lords, I want to ask the Minister a question that arises from this change. First, though, it is over six months since we debated these amendments. That does seem like an awfully long time for the Bill to disappear into limbo and come back, particularly when other Bills are being rushed through this House. I wanted to ask the Minister to explain more about whether the resolution process could be used for larger banks, but I think he has actually answered that question. I am not sure his answer gives me an awful lot more confidence or comfort, but I am not going to oppose the Commons amendments. However, in the last six months, various comments have come from the PRA or the Bank of England about the fact that this Act, as it will be, may allow them to take some banks out of the MREL process. I wondered if the Minister might wish to comment on that and whether there are any consequences the other way round.

My Lords, I have to say that I appreciate the explanation that we have just had from the Minister, but I and others remain disturbed by the Government’s decision not to accept the amendment, which was not just rational but well crafted, introduced by your Lordships in this House. The underlying Bill was initially presented to the House as providing a mechanism to save significant small banks from failing by recapitalising them from the Financial Services Compensation Scheme, rather than having to turn to the taxpayer. Regulated banks, as this House will know, are then required to replenish the FSCS when it is depleted for any reason, but, because the thrust of the language was around small banks—that was the intent, and that was the discussion that is in all the notes—this House very much agreed to it, with just a few probing points engaged with. Thank goodness that we have a lot of very good brains in this House. The combination of my noble friends Lady Bowles and Lord Fox and the noble Baronesses, Lady Noakes and Lady Vere, realised that there was a significant loophole in the language. We did not realise in the beginning that any of this could be applied to the larger banks; that became clear only as those pursuing the legislation became more aware of the implications of its content. Now we have a Bill that permits the regulator to use the FSCS as its mechanism to rescue large banks. Let us be frank: it completely changes the whole profile of both risks and consequences. The amendment would have effectively closed that loophole. The larger banks, as the Minister has said, already have their own dedicated process to recapitalise in case of failure, a process that was introduced after the 2008 crisis. The Bank of England requires each large bank to hold a tranche of MREL—in plain English, bail-in bonds—which can be converted to capital by the regulator in case of failure, with the consequence that the bank is thereby rescued. We need to understand why that is not considered by the Government to be an adequate system. The Minister has just said—if I understood him—that the regulators will always require that bail-in bonds are used first, and the FSCS is a resource of last resort. But that is not in the legislation. The legislation allows the regulator to turn first to the FSCS and ignore bail-in altogether. He will be very conscious that the Swiss regulator, with the failure of Credit Suisse, completely ignored the bail-in capability and chose other routes to manage the rescue of Credit Suisse. Those who hold bail-in bonds—the investors who buy them—are extremely well remunerated for carrying the risk associated with a bail-in bond. I am trying to work out why they can now look at this legislation and begin to assume that they will have the benefits of receiving a risk premium for holding those bonds but never actually find that those bonds are forced into use in case of a failure. How can we rely on just a code to continue to determine that bail-in will be the first resort and not a later resort or no resort at all? Are the Government basically saying that there are now many circumstances they have identified in which bail-in is neither usable nor adequate? I refer to the Swiss example. What are the consequences for financial sustainability if we are saying that bail-in is a slightly busted system? Have there been blandishments from the various investors who have purchased bail-in bonds, trying to pressure the Government into creating an alternate route? What are the consequences for our small- and medium-sized banks if the FSCS is depleted by big bank failure? The Minister says that the regulators will not ask for an unaffordable contribution from the various banks to replenish the FSCS, but it is our mechanism that ensures small depositors’ accounts. Who is going to do the replenishment if the number is too great to ask the banks to commit to it? I am quite troubled by this change in responsibility for where risk lies that is embedded in the Bill. If the Minister is so sure that the items in the code should be giving us reassurance, why have they not been introduced in this Bill as part of the legislation?

My Lords, this is an important Bill, which provides the Bank of England with extra flexibility to manage bank failures, particularly those of smaller banks, in a way that strengthens protections for taxpayers. It reflects proposals by the last Government in the light of experience with the demise of Silicon Valley Bank. As such, it had cross-party support and, starting in the Lords, was a good example of expert scrutiny across the House. Special thanks go to my noble friend and predecessor Lady Vere, my noble friends Lady Noakes and Lady Penn, the noble Lords, Lord Vaux of Harrowden and Lord Eatwell, the noble Baronesses, Lady Kramer and Lady Bowles, officials on all sides—of course, not forgetting the Whips—and, above all, the Financial Secretary to the Treasury, the noble Lord, Lord Livermore. I thank him both for the government amendments, notably that which was made to Clause 3 on the involvement of the Treasury Committee and the House of Lords Financial Services Regulation Committee, and for the timely publication of the draft code of practice, which helped us to overcome some substantial difficulties, as he has already mentioned. Banking and financial services are very important to the success of the British economy. In 2022, the UK financial system held assets of around £27 trillion and in 2023 the financial insurance services sector contributed £208 billion to the UK economy. Legal regimes which govern how our banking and financial sectors operate need to promote growth and competitiveness and be easy to navigate and use. They must also balance ambition with prudence—an understandable driver of the Bill. Noble Lords will recall the amendment we successfully added that was championed by my noble friend Lady Vere. This sought to prohibit the use of the funds from the Financial Services Compensation Scheme to recapitalise large financial institutions, defined as those which had reached an end-state MREL. The object was to reflect in law the Government’s stated objective of using the resolution framework in the event of a smaller bank requiring intervention, thus preventing the associated risk of contagion. The truth is that the Banking Act 2009 provides a robust framework for dealing with the large banks that have achieved end-state MREL status. They and the Bank of England should not be taking comfort from the fact that they could fall back on an ex-post levy of the banking sector through the FSCS in times of trouble. Resources should be focused on the SME banking sector, as the noble Baroness, Lady Kramer, reiterated. In view of this, I am joined by noble Lords across the House in expressing disappointment that Members in the other place voted to remove this amendment from the Bill. We are confident that it would have improved the Bill in meeting its objective and helped to embed the balance I spoke of. However, we must accept that Treasury Ministers, with their battalions of support in the other place, wish to maintain flexibility; for example, as the Minister explained, to deal with a large, unexpected redress claim leaving the taxpayer exposed, although this is very much a backstop arrangement, with a £1.5 billion cap, as the Minister confirmed. So I do not propose to test the opinion of the House again. It was also disappointing to see the rejection of other prudent proposals put forward by colleagues in the other place in good faith. Regardless, I hope the Government will consider these proposals seriously as we try together to create a system which is balanced and simple and promotes growth—an objective that the Minister and I share. We support the thrust of the Bill, which continues the work that we did in government to support our banking sector, protect consumers and safeguard the public finances. However, there are still outstanding questions which I hope the Government can address today or in writing. They are even more important now that the Vere amendment has been rejected. The Financial Conduct Authority and the Prudential Regulation Authority have proposed an FSCS operating budget for 2025-26 of £109 million. This budget covers the FSCS’s administrative expenses and does not represent the total funds available for compensation payouts. Over the three financial years from 2021 to 2024, the FSCS paid just £10 million in compensation relating to deposit claims, due primarily to the defaults of 11 credit unions and one small bank. Will the Minister kindly outline the steps the Government are taking to minimise the operating costs of the FSCS? The FSCS is a quango, which is overseen by a quango, in conjunction with another quango. The fact that it uses an industry funding model does not change this. The money in its operating budget is money that is not being utilised in the banking sector, which employs millions of people and contributes billions to our economy and to growth. Does the Minister agree that the FSCS should focus on efficiency and on keeping as much money as possible available to banks for their use and not tied up unnecessarily in its operating budget and that, like other regulators, it should have regard to the Government’s overall objective of growth? I end by saying that this is a broadly sensible proposal designed to safeguard public finances, ensure the security of our financial sector and limit public risk. We will support the Government in their ambition to achieve the objectives of the Bill, but I hope the Minister will seriously consider the points that have been raised today and will take the opportunity to clear up some of the questions that have been asked.

16:00:00

My Lords, I again thank all noble Lords for their efforts on the Bill since July last year, and all noble Lords who have spoken in this brief debate today. I am also grateful to all three noble Lords for indicating that they will not oppose the Bill further. I will briefly attempt to respond to the questions and points made in this brief debate. First, I reiterate what the noble Baronesses, Lady Kramer and Lady Neville-Rolfe, said about the expertise in this House; I was on the receiving end of much of that expertise and it certainly tested me. However, to a large extent, the Bill was improved by the debates we had in this House, and I am grateful to all noble Lords for that. The noble Lord, Lord Vaux, talked about the gap between Third Reading and us returning today for this ping-pong session. It is somewhat out of my hands, although I do agree that it feels like rather a long time since we last debated these issues. He asked about the circumstances in which this power will be used, and I hope, as he said, that I covered that in my opening speech. He also raised some other questions. On MRELs, the Bank of England sets MREL requirements independently of government, as he knows, but within a framework as set out in legislation. The Bank of England has consulted on proposals which seek to ensure that the MREL regime remains proportionate and evolves over time. The Government are engaging closely with the Bank of England as it considers its responses to that consultation, and its engagement includes consideration of the impacts on economic growth. The noble Baroness, Lady Kramer, talked about MREL being used as the first resort. The Government believe there are sufficient safeguards in place to ensure that shareholders and creditors are exposed to losses before the new mechanism is used. These include the principle in legislation requiring the Bank of England to ensure that shareholders and creditors bear losses when a banking institution fails. As set out in the draft updates to the code of practice, the Bank of England would first look to write down or otherwise expose to loss all readily available MREL resources before requiring a recapitalisation payment from the FSCS. Noting these points, the Government believe that specifying the extent of losses that must be imposed before the new mechanism is used would be an unnecessary restriction on the Bank of England’s flexibility. The noble Baroness, Lady Neville-Rolfe, asked about the FCSC budget and minimising operating costs. It is in fact a legal duty on it to minimise those costs, and I would expect it to adhere to that legal duty. The noble Baroness also spoke about the importance of financial services to the growth of the UK economy, on which I very much agree with her. The Bill plays a vital role in upgrading the UK’s toolkit to manage bank failures, strengthening protections for taxpayers and financial stability which are, in turn, key to the Government’s number one priority of economic growth. I look forward to the Bill’s enactment and I hope noble Lords will join me in supporting the amendments made in the other place. I beg to move.

Motion on Amendment 1 agreed.

Motion on Amendment 2

Moved by

That this House do agree with the Commons in their Amendment 2.

2: Clause 8, page 6, line 1, leave out subsection (5)

Motion on Amendment 2 agreed.