David Ruffley MP questions Stephen Hester and Bob Diamond on the Independent Commission on Banking

Wednesday, 8 June, 2011

On the 8th of June 2011 David Ruffley MP questioned Stephen Hester and Bob Diamond on the Independent Commission on Banking.
Mr Ruffley's interview can be found below and the dull text of the proceedings can be found here

Q162 Mr Ruffley: Mr Hester, in the ICB, we see, in annexe 3, the statement-I think it is commonplace-"The prospects of Governments intervening to bail out systemically important banks effectively subsidises them." We are on to the good old subject of implicit guarantees that the British taxpayer gives to all banks. I am not particularly talking about the particular cash bail-out that your bank benefited from. Could you tell us what the size of that subsidy is, approximately, for the whole of the industry, not just your bank? What do you think it is worth to British banks?

Stephen Hester: I think that as far as I can understand, not being a professional economist, this is a subject on which there has been no ability to get economists to agree, and there is a very wide range of different estimates. What I have personally focused on in the couple of years or so that I have been in the job and worrying about a systemic bank is: how do we make sure that, whatever the number is, we eliminate it? I believe that the extensive reform processes that are under way and in train will do that job, whatever the number is. I suppose I have not found it productive to be more expert than the economists who cannot agree on the subject.

Q163 Mr Ruffley: Yes. In annexe 3 there is reference to the Oxera report, which I think your bank commissioned.

Stephen Hester: You see, all these are backward looking, and to me-

Mr Ruffley: Of course.

Stephen Hester: -we must learn lessons from the past, but what are more important are the forward-looking issues. Forward looking, have the reforms that are in train done the job, or will they have done when they are completed by doing the subsidy?

Mr Ruffley: Sure. Just stick with this. The ICB, of course, does, in annexe 3, attempt to reconcile the Oxera number, which I think your officials rely on, and also the Haldane work from the Bank of England. The ICB, reconciling all this, says that the subsidy is worth considerably in excess of £10 billion per year for the whole of the industry. Do you recognise that figure? Do you think that is about right?

Stephen Hester: I recognise what you are quoting from, and all I can say is, I know that there is a whole range of academic and practitioner dispute.

Mr Ruffley: So you do not think that is a fair estimate?

Stephen Hester: As you point out, Oxera came up with a smaller one. I am not sure that I see the ability or even the benefit of agreeing what the number is. The point is, whatever the number is, let's try and make it zero in the future and let's examine the reforms that are going through to help achieve an outcome.

Q164 Mr Ruffley: With the greatest respect, if you want to reduce it to zero and you do not know what it is now, how do you know you have reduced it to zero?

Stephen Hester: I think that is because we have to examine the sources of potential public subsidy and the circumstances that might lead to banks calling for Government support and address them.

Q165 Mr Ruffley: We will have to come to a number, won't we?

Stephen Hester: I don't believe so. The best brains have not been able to so far, but what the best brains around the world have diverted themselves to, through the Basel process and being associated with it, is how to reduce and eliminate the things that weakened the banking system so greatly, and I think that is the best use of time and effort.

Q166 Mr Ruffley: Sure. With regard to the ICB proposals, what are the things you are going to support in this document that will get the subsidy to zero, which is your stated intention?

Stephen Hester: The things that we support include-maybe this is not an exhaustive list, but the ones off the top of my head-strong capitalisation for banks in equity terms; strong liquidity, in all cases stronger than the past; resolution powers that allow the authorities to take banks apart in whatever way is necessary in a crisis, and that may not be the way that we design now or that a particular view today might be-a crisis could have any shape in the future-and bail-in powers that say, "If, in extremis, more capital is needed, there is a hierarchy of where you get from and the Government does not appear on that hierarchy".

Those are the crucial ingredients of ensuring that, first, banks are less likely to fail in the future; secondly, they have much greater capital resources to fall back on if they fail; and, thirdly, even if they then run out of those capital resources, that creditors pay rather than the Government. I think that these are the crucial things and, indeed, this is the view of all the international authorities because these are the pursuits that Basel all around the world is doing that really will address the issue, and I truly believe they will address the issue once they are through. The Commission is quite eloquent in supporting and explaining its support for all those features.

Q167 Mr Ruffley: I realise you do not want to dwell on what the estimate of the value of the subsidy may be, but for your bank-not the industry, for your bank-what do you think it is worth?

Stephen Hester: I suppose, at its most fundamental, we know-

Mr Ruffley: Is it higher than £1 billion or less than £1 billion?

Stephen Hester: -RBS would have gone into liquidation were it not for Government support, so on one level you can say that was the measure and that is, in a sense, what has given me and my colleagues a huge interest coming in, as it were, after the event to try to think about what the sources of weakness were, what the way they were transmitted is, and what the right reforms are, both to our own bank and more broadly, to avoid that. I think we have had a very close-up view of these issues, as it were.

Q168 Mr Ruffley: You want to eliminate it and I think the British taxpayer would want it eliminated, but, as you know, Sir John in the report says that total abolition and elimination of the implicit subsidy to all the banks that the British taxpayer provides is unlikely. Do you agree with that?

Stephen Hester: I think that it is likely that if all the reforms that we have talked about and that are under development and rolling out around the world are prosecuted, it will not be necessary in the future for the Government to support, through capital, banks in a crisis. I do think that there is a normal function of all central banks, which is liquidity support-that is a very different matter-but, in terms of capital support, I do think that can be avoided in a future crisis.

Q169 Mr Ruffley: Could I ask whether you think any of the implicit subsidy has fed through to bonuses and high remuneration at RBS?

Stephen Hester: I think, to the extent that banks were able to carry less capital and fund cheaper in the past than would be true in the future, then one can say that that implicit subsidy, whatever its amount, could have fed through to lots of places. Obviously it could have fed through to the price of loans to customers and, therefore, to the general economy. It could have fed through to the levels of employment in banks, in all bits of banks, and it could have fed through to bonuses, so I think one could assume that there might have been some leakage to all of the above.

Mr Ruffley: Including bonuses?

Stephen Hester: I think that is entirely possible.

Q170 Mr Ruffley: What do you understand by the phrase "explicit non-guarantee" that is used by members of the Vickers Commission?

Stephen Hester: I think I might have to say "pass" on that.

Mr Ruffley: You have heard of the expression? Sir John has used it in the Vickers Commission-

Stephen Hester: I am afraid I haven't memorised the report and so immediately that phrase is not springing into my mind.

Q171 Mr Ruffley: I can help you. You very helpfully said to this Committee that you wished the British taxpayers' subsidy to the banking system, which is very generous of them in my view, to be reduced to zero, certainly in relation to your own bank, which is good. We like that. But what is going to happen if you do not get to that zero point and, more particularly, what happens if the Government say, "The way we get to this zero point is to say we are not going to bail out RBS in the future"?

Stephen Hester: There was a series of reforms that have already happened and some that are rolling out. One reform, of course, which is already enshrined in the Banking Act, is that the regulators can at the point of failure take any bit of any bank and say, "That is going down and this bit is not going down, and this is how we are going to deal with it". These are the powers that they have. The US have given themselves that power as well. In fact, they used it at one point in the last crisis, in WaMu. How are we to know today what the shape of a future crisis will be, what the points are and what the bits that are going to be essential to economy are or are not? It is very hard to know that today.

There are very sweeping powers that the regulators have-I think, correctly-that, of course, were not there before that will allow those choices to be made in a crisis, if necessary. Now, I hope that that will not be necessary and that there will be many steps before that in terms of capital liquidity and CoCos and so on to get there, but there is, I think, that insurance policy.

By the way, in a less perfect earlier guise, this was used in Bradford & Bingley. Bradford & Bingley was separated into two at the point of crisis and some bits were kept going and some bits were not. The powers have been greatly improved that are available to the authorities since that occasion, so this is not new stuff, although it has been taken on a great deal further, and I think it is an essential piece of the armoury that will allow us to treat the problems of the future and not to have to imagine them today and perhaps get them wrong.

Q172 Mr Ruffley: Final question, Chairman. Is it the case though that if there is some element of subsidy remaining, you are wanting to keep this support from the Government, and that in extremis you would want to say to the world, "This is not going to go down. Not everything is going to be lost. The taxpayer will stand behind some of this business", but if you do that, you are going to get the implicit subsidy because you would be able to borrow more cheaply in world markets than if you didn't have the taxpayer standing behind you?

Stephen Hester: As I meant to say, I think the stated objective of world Governments, not just the UK Government, to not be in a position where Governments provide capital support in a future crisis is the correct one, and I think that is the one to which we should all be, and indeed are, working. Now, that does not mean to say that crises will be avoidable, but I think that there are a whole series of ways of absorbing those losses or letting people suffer the losses that would be-

Mr Ruffley: Before the taxpayer has to pick up the tab.

Stephen Hester: Absolutely. Yes, I think that should be the objective.

Q271 Mr Ruffley: Mr Diamond, as you are aware, the ICB says of the implicit subsidy, "The prospect of Government support cheapens bank funding by considerably in excess of £10 billion a year for the whole of the UK banking industry". Do you think that is a fair estimate?

Bob Diamond: I was watching much of the testimony that you had earlier out of interest, and I think I would echo what Douglas said, because it's exactly what I would have said. It's really hard to put a pin in this. It's very different in varied markets. It's different in different environments. During the crisis it was quite large, I think. I think the real issue here is that we work very hard together to make sure that there is no implied Government subsidy going forward. I think the impact of it-

Q272 Mr Ruffley: You said when you came to see us earlier in the year that you were not happy receiving this implicit subsidy for your institution. I think that was where you first said it. Why are you so keen to get rid of this subsidy? Why is it important that you get rid of it?

Bob Diamond: It begins very simply with the fact that strong banks want strong regulation, and I said in January when I was here that no bank suffered more than the banks that were healthy and survived because of the failure of other banks. It is of benefit to Barclays to have strong regulation and strong supervision.

We have worked supportively on Dodd-Frank; we have worked supportively on Basel; I was in Frankfurt last week; I was in Milan a couple of weeks before that working with the FSB, so we are not against strong regulation at all.

Secondly, as I said in January, no bank should be too big to fail. No taxpayer money should ever be put at risk, and we agree on that completely. In my mind, the way that works, which gets directly to your answer, is that I believe there is a benefit to the economy and to job creation of having banks like Barclays that can help their customers do business around the world, and if banks are too big to fail then the answer we have is to get rid of big banks, which I think is the wrong solution, or find ways that they can fail without creating systemic risk to the economy and to the financial system, and that is resolution and recovery. We are very supportive, and I think we are way down the road with the FSA in having Barclays fit for purpose on resolution and recovery. So, if there was a problem, the regulators would be comfortable that they could walk in and separate the deposits, the small businesses, the branch-based system and the money transmission.

Mr Ruffley, we have spent about £30 million this year in developing a technology to get us to that position, so we are very much in concert. If we can do all of that, we have removed the implied Government guarantee.

Q273 Mr Ruffley: I understand that, and that is useful to have on the record. Why do you think Sir John Vickers says in his interim proposals that if those proposals are implemented, a total abolition of the implicit subsidy is unlikely? How would there be some residual subsidy, in your view? Because you want to eliminate it altogether, don't you?

Bob Diamond: Yes.

Mr Ruffley: Why do you think Sir John said that? Why would there be some residual subsidy after all these measures are put in, assuming they are implemented in full: bank resolutions and bail-in and so on and so forth?

Bob Diamond: I think if those solutions-the package, as we call it-are implemented on a level playing field across the major economies then we have removed the implied Government guarantee. I do worry that, in addition to the package being approved, if you take an extreme view of ring-fencing-now, I'm saying an extreme view, and it is not at all clear to me that is where the Independent Commission is-it makes the implied guarantee almost explicit in terms of UK retail deposits, and that may be what he was alluding to. I'm not sure.

Q274 Mr Ruffley: Do you want to define for us what you understand by "extreme ring-fencing"?

Bob Diamond: I think "extreme" would be Glass-Steagall; a complete separation of wholesale and retail banking or investment banking and retail banking, however you define it. It is broadly recommended by the Independent Commission that this is not ring-fencing capital; it is ring-fencing deposits. We are working very closely with them so we feel this is a workable solution that doesn't have a big cost to the economy and doesn't create an explicit guarantee. Again, we are early in the process and I have nothing but good things to say about the thoughtfulness of the people in the Independent Commission on Banking. They give us all the access to them and are providing a lot of information, so I am very optimistic that we will come out in the right place, but certainly it is still early days.

Q275 Mr Ruffley: If I could just go back to the implicit guarantee, you're a very experienced banker. Don't you have a figure in your head as to what the value of the implicit guarantee is to your institution? Is it more than £1 billion or less than £1 billion?

Bob Diamond: I am sorry; I don't mean to be obstinate at all. The reason I don't, Mr Ruffley, is that I believe that this is not a guarantee that was given by Government. It is an implied guarantee that is given by the market. It is given by investors. It is investors making an assumption if something went wrong and, therefore, funding at different levels. For Barclays or for JP Morgan or for HSBC who are all then in the same situation where the investor is making that decision, what it leads to is lower LIBOR rates, and since our business is priced off LIBOR, it has a very positive impact on borrowers and a potentially negative impact on savers because it can potentially lower LIBOR. But it doesn't have a direct pass through into banks if in fact, as you have said, it is an implied Government guarantee for the system, because what it impacts is the LIBOR rate. It doesn't flow through into banks.

Q276 Mr Ruffley: Yes. The obvious implication of getting rid of the implied guarantee is a transfer-and these are the words of the ICB-of the subsidy, the cost of that. To use its words, "It shifts to the banks from the wider public." I think we have to assume that is the taxpayer. Do you accept that when the implied guarantee is substantially removed or indeed abolished, there will be higher costs for your bank?

Bob Diamond: I think there could be. I think the real issue, to come back to the first principle, is if this is the investors making the assumption and then they no longer make the assumption, we will see higher LIBOR rates. To the extent that it is to the whole market then we will see it reflected in the funding rates.

I think the difference, Mr Ruffley, is that there have been direct subsidies. Certainly the taxpayers in the UK gave money directly into Lloyds and into RBS, and that is the real impact at the end of the day, and that is very different. I am so positive on the package of reforms and the fact that we can end this "too big to fail" so that if there is a large bank that gets into trouble or a small bank that gets into trouble, they can be allowed to fail. I think it is critically important that banks be allowed to fail, because we want our banks to take risk. We want our banks to be lending. We want our banks to be investing in small companies. They need to be allowed to fail, but what we want is failure without the systemic risk or risk spilling over either into taxpayer subsidies or into turmoil in the financial markets.