Revealed: a blueprint for banking reform

An archbishop, an economist, a former Chancellor and a former head of the Civil Service are not often brought together to form an opinion on the great affairs of state. But it is not often that a country goes through the type of financial crisis experienced by the UK over the past five years.

As early as this Wednesday, the Commission on Banking Standards is set to publish its final report on how to clean up the banking industry in the wake of a spate of scandals which culminated with the revelation that the Libor interbank lending rate was being manipulated. The commission’s job, put simply, was to plot how to put “trust” back in the financial services industry and stop the calamitous events of 2008 and 2009 ever happening again.

Convened last July by George Osborne and under the chairmanship of Andrew Tyrie, the Conservative chairman of the Treasury select committee, the commission was given the task of improving professional standards and the culture of banks.

Hand-picked by Mr Tyrie, the commission’s 10 members include the Archbishop of Canterbury, the Most Rev Justin Welby; Lord Lawson, Margaret Thatcher’s longest-serving Chancellor; and Lord Turnbull, a former head of the Civil Service.

Having listened to more than 150 hours of evidence, read thousands of pages of written testimony, and been the subject of relentless lobbying, the commission is now ready to release its 568-page report, a draft copy of which was couriered to members just over a week ago.

Over the course of more than seven months of hearings the commission has heard from many of the senior figures in the British financial system including the chairmen and chief executives of all the major lenders and some of the country’s top investment bankers and regulators. Mr Tyrie and a small team of aides took two months to write this final, definitive tome.

Ahead of its publication and after speaking to key figures close to the commission, The Sunday Telegraph reveals the key areas the report will cover.

A better functioning banking market

It is clear the commissioners believe that banking, in particular retail banking, could do with more competition.

Among the recommendations expected will be how to lower barriers to entry for challenger banks. This is likely to focus on making it cheaper and easier for entrants to access payment systems, as well as reducing the regulatory hurdles that start-ups must pass.

The commission welcomed moves earlier this year to lower the capital requirements for new banks. The report is looking at recommending further changes to reduce the regulatory and capital burden on smaller lenders.

Free retail banking for customers will also be in the spotlight. Mr Tyrie has shown his dislike for free-if-in-credit-banking, pointing out that it makes it more difficult for customers to work out if they are getting value for money from their bank.

Peer-to-peer lenders will be among the businesses featured in these recommendations.

Approved persons regime

Lord Stevenson of Coddenham, the former HBOS chairman, raised eyebrows during evidence to the commission when he revealed that he remained an “approved person” under the Financial Services Authority’s regime for several years after leaving the defunct lender.

“Are you a non-executive director of Loudwater Investment Partners?” asked Mr Tyrie. “Yes…no, no, I am not. I used to be,” replied Lord Stevenson, before Mr Tyrie pointed out that he had only gone “inactive” on the FSA’s system a week before the hearing.

The evident dissatisfaction with the current regime, which the commission is expected to say has failed, is likely to see a call for the way the regulator approves individuals to be updated.

This could mean handing the approval power to a new professional standards body, which would be able to make qualitative judgments about the fitness of individuals to work in finance, versus the legalistic and procedural regime currently in place.

The commission will make it clear that it does not want to see a new system that is overly slow in taking decisions and the emphasis of its recommendation is likely to be focused on the most senior individuals, such as board-level appointments and managers in charge of materially significant business lines.

Bank governance

Building on its damning report into the collapse of HBOS and the FSA’s work on the failure of the Royal Bank of Scotland, the commission is expected to make several recommendations on how banks are run. Of the commission’s 11 sub-panels, two were dedicated to looking at the issue of governance, both at board-level and below.

Ensuring those at the top of banks are appropriately qualified is likely to be among the key recommendations. The lack of banking experience at the top of HBOS and RBS was highlighted by the commission and the FSA as a factor in their failures, with too few people on their boards able to properly challenge senior managers.

Of particular concern to the commission has been how to make directors of large banks more personally accountable for the failure of their institution. This could include a recommendation for directors to have a more explicit fiduciary duty not just to shareholders, but to other stakeholders such as depositors and the state.

An extreme measure would be to introduce some form of unlimited liability for directors, giving them a similar financial stake in the health of a bank as the partners of a traditional merchant bank.

Remuneration

Bonuses and bankers’ pay have been among the most politically sensitive issue since the onset of the financial crisis and though no specific hearings were held on the subject, 48 pages of the report are understood to have been dedicated to looking at what can be done about remuneration.

The commissioners have shown little appetite for rules such as a bonus cap that would forcibly limit pay and recommendations on compensation are likely to focus on ensuring that it is better aligned with performance and subject to stronger malus clauses to allow a bank to claw back pay should its performance take a turn for the worse.

Regulatory and supervisory approach

Along with the banks, the commission’s hearings have frequently explored the performance of Britain’s financial regulators in the run-up to the financial crisis as well as how they fared during the crash and its aftermath.

Given this is such a broad subject it is expected to be one of the largest sections of the final report – in the draft document it takes up 70 pages.

Among the key recommendations is likely to be further detail of the commission’s views on the leverage ratio – the measure of a bank’s capital as a proportion of its total assets.

Previous reports have made it clear that the commission would like to see a ratio in excess of the minimum international standard of 3pc, or 33-times levered, and of at least 4pc, the level recommended by the Vickers Commission in 2011.

“We’ve been clear that we think the leverage ratio is a necessary tool for the stability of the financial system,” said one commission member.

Another important issue the report is likely to deal with will be the international regulatory backdrop. As a member of the European Union, any rules the UK implements must be compatible with EU law and the commission will be mindful it does not recommend changes to the regulatory approach that would be legally impossible.

Sanctions and enforcement

There was much excitement earlier this year when Tyrie appeared to suggest in an interview that he was in favour of stronger criminal laws for bankers.

“What really sticks in the craw of the electorate is that what you and I would consider to be very serious offences have been committed, and yet there doesn’t seem to be an orange jumpsuit on anyone,” he said.

Mr Tyrie has since steered away from the need for new criminal law and the commission’s report is expected to reflect this view. Instead, the commission is likely to suggest more rigorous enforcement of the UK’s existing criminal law for fraud and market abuse.

Regulatory structure

At the start of April the UK’s new regulatory regime came into force with the disbanding of the FSA. In its place have come the Prudential Regulation Authority, the Bank of England-run supervisor of the banking industry, and the Financial Conduct Authority, which took the bulk of the FSA’s staff and its market oversight powers.

In several evidence sessions, senior regulators and government officials have been quizzed on the new set-up and how it will operate in any new crisis.

Of particular concern has been the vast increase in the Bank of England’s powers, with questions raised about how to hold the newly-empowered central bank to account.

Ensuring accountability has seen testy moments between the commission and Sir Mervyn King, the outgoing Governor, who has bristled at the suggestion that the Bank’s governance may not be fit for purpose.

The report will suggest ways to ensure that the new regulatory structure is subject to periodic reviews to ensure it is still delivering the best outcome for bank customers and the financial services industry.

Resistance to reforms

One of the first areas the commission’s report will tackle is the degree of industry resistance to change. Mr Tyrie and other commissioners have made no secret of their displeasure at what they see as the inordinate influence of bank lobbying on the political and regulatory process.

In private, commissioners have criticised the way any move to introduce radical industry reform has often been quickly quashed with warnings from lenders about the impact on the economy.

“There has been a degree of political capture by the banks of the Government,” said one commissioner.

However, this is not just an issue of big banks putting off change, but smaller lenders, particularly building societies. A telling exchange in February with Mr Osborne hinted at a high degree of lobbying from the mutual sector over the introduction of a leverage ratio. “Some of these institutions – when you hear or see their names, they are not the names that spring to mind as the ones engaged in the riskiest banking activities – feel that a 4pc leverage ratio would do,” said the Chancellor.

Asked by Mr Tyrie whether these banks had been “lobbying the Treasury”, Mr Osborne said “they have made representations to the Treasury”. “They seem to have been quite persuasive,” said Mr Tyrie.

Tackling the legacy of RBS

Among the nearly 600 pages of the report, 29 of them have already proved particularly controversial after it was revealed last week that the commission intended to set out a series of “radical options” for RBS. Among the proposals are a suggestion that the Government could split RBS into several regional banks, separate it into a “good bank” and a “bad bank” and look at various options on distributing the state’s 81pc holding in the lender to the public.

The report is expected to set out a September deadline for the Government to come back with what it proposes to do with RBS.

In a particularly harshly-worded section, the commission is understood to warn that the status quo is unsustainable and damaging to taxpayers’ longer-term interests.

“We will be telling them that to continue as we are is not an option,” said one member of the commission.

One commissioner said he did not think the report needed to contain the section. “This is supposed to be a report on the standards and culture of the banking industry and it makes no sense to me to devote a section to the future options for one particular bank,” said the commissioner.

Another member expressed concern that the eventual solution to the RBS issue would be to produce a split report, whereby it would be noted that not all members supported the specific recommendations on RBS.

“It would be an immensely bad thing if we had to go down this route and the hope has got to be that an agreement is reached,” said one commission source. The section could still be rewritten.

The way forward

Throughout the hearing process witnesses have often been set “homework” by the commission, with requests for further detailed information when discussing a particularly technical topic.

For all its length, the commission’s final report is likely to ask as many questions as it will provide answers and the expectation is that the Treasury, Bank of England, as well as the main regulators, will all be required to provide their own detailed responses to the document.

“They asked us the question, but it is only right that the Government should now go away and do its own work on this as we couldn’t possibly work through all the detail ourselves,” said one commission member.

How Mr Osborne responds will be dependent on the timing of the report’s release. With the commission scheduled to meet over the course of Monday and Tuesday to discuss the final report, it could be that it will be published as early as Wednesday.

This would give the Chancellor and his team at the Treasury plenty of time to incorporate its conclusions into his annual Mansion House speech on June 19.

Like the commission’s previous reports, it is certainly possible the document will contain a proposal for a review of the impact of its recommendations, should they be implemented, further down the line.

As with the Vickers commission, Mr Tyrie and his colleagues will be acutely aware that their proposals are likely to be overtaken by developments in the financial markets and will want to ensure that they do not go down in history as the men and women who failed to spot the signs of the next financial crisis.