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Building Britain's Banking Future

Rt. Hon. Lord Mandelson,  First Secretary of State, Secretary of State for Business, Innovation & Skills, Lord President of the Council
British Bankers Association Annual Industry Dinner, Mansion House, London,  29 June 2009

Introduction

My thanks to Angela, who has been a stalwart voice for the industry through an incredibly tough two years. Probably the toughest tenure of anyone in your position for a very long time. You have a great team behind you. And I congratulate you all for your work.

If there is any respite it is that there are some tentative signs that the financial system is stabilizing. There are signs of life in both equity and bond markets and share prices have regained a little ground. Interbank rates are down and the main lending banks are certainly more open for business – and that’s a message we have to get out to the rest of the UK economy and to the world.

And although there’s perhaps not a lot of sympathy out there, I do want to acknowledge the thousands of workers in the banking and finance sector who have lost their jobs over the last year. Most of whom didn’t have large pensions to look forward to.

In the real economy things remain extremely difficult, but on average 200,000 people a month move off unemployment in the UK and there is evidence that after working down inventories, managers are gradually starting to build up stocks again.

It’s very fragile, but it reinforces the fact that the government’s bold intervention to stabilize the banks and maintain demand in the economy was absolutely the right thing to do, all the more courageous as the Prime Minister did not have much peer group solidarity at the time when we made our first moves. The subsequent coordinated action that was taken internationally will, in time, also be vindicated.

Our economic resilience demonstrates that the flexibility of the labour market we have built on since 1997 is a great asset at times of strain. As is our commitment to supporting those who lose their jobs with training and help finding work.

We have worked closely with you over the last year to ensure that lending to small and medium sized firms is maintained. Especially for those small and mid-sized firms that can’t go to equity and bond markets. The lending guarantees and the working capital guarantee have both helped do that, and they are a reminder that the government’s purpose in stabilising the banks was the resumption of credit in the real economy, which is critical to all our recovery. So there are clear expectations that credit must be available – and not just available, but reasonably priced as well.

The next step for the banking industry

But of course surviving the credit crunch is only the first step for the financial sector and the banking industry in particular. Repairing its balance sheets is the second. What I want to speak about this evening is where we go from here and what we do to put the financial sector on a sound footing for the future.

That process is going to test the appetite for change from an industry that’s not used to this degree of scrutiny and criticism. One that’s not used to having its prerogatives questioned. Now obviously, different banks and financial institutions have weathered the last two years – and managed the last ten years - in different ways. But I think we can speak of a challenge for the industry as a whole.

And I have to say this. In a decade or more of exposure to businesses on pretty much a day-to-day basis, I have never felt such a sense of distrust and anger between the financial sector and the rest of the economy that exists.

People are furious about risk taking and astronomical pay. People are asking how financial services appeared to move so easily from being an asset to a liability to the economy.

And people who are on short-time working or face the prospect of redundancy or their business failing will be looking askance at reports of bonuses being paid out again, unless these really are tied to the toughest of challenges and achievement, and even then for many they will be hard to swallow.

Now, let me quickly add that I understand that people are equally looking askance at the behaviour of many politicians as well. Politicians and bankers share a need to demonstrate to the public that we are getting our houses in order. Politics and banking both ultimately work on trust. That’s the currency of both. Well, we have to ‘re-mint’ that trust in a serious way.

Rules will not replace judgment

When the government publishes its Financial Services Strategy it will be clear that we are committed to the success of this sector. And I personally feel a very strong commitment to financial services, because for all the years I was traveling round as EU Trade Commission and beyond, I know how important they are to Britain’s international standing and investment - an absolutely solid and indispensable platform for our position in the global economy.

But it will be equally clear that we are convinced that the status quo ante is not an option. The FSA and the EU are both going to get a new rulebook. Things are going to change.

These rules will shift us to greater macro-prudential supervision – looking out for systemic risk. They’ll create new capitalization requirements that lean into the economic cycle and account better for different kinds of risk. They’ll reshape the landscape for derivatives.

They will have to address the important fact that it is not the bigness or smallness of banks that matters so much as the implications of their failure for the rest of us.

Where institutions operate under an explicit or implicit government guarantee because of their deposit bases or role in the market, then they must clearly be expected to take a fundamentally different approach to risk and failure.

These are necessary shifts in a regulatory framework that must have the medium term stability of the financial system as its core priority.

In this country we are also going to use the forthcoming Consumer White Paper to put the squeeze on unscrupulous selling, including of financial products.

As many people have argued, we will also need to look at how best to enhance the Tripartite system - the coordination between the Treasury, the Bank of England and the FSA.

The Bank’s role in financial stability issues has already been strengthened, with a new statutory duty and a Financial Stability Committee. But while I think there is an argument for the Bank taking a more direct role in financial stability issues, I don’t support a twin peaks system of regulation. I believe the lesson of the last year or so is that we need a stronger regulator, not a weaker one. Others are moving towards consolidation because they have seen it work well here.

We need to keep prudential and conduct of business expertise in one place, in a regulator capable of seeing all parts of the picture at once. That regulator has to be the FSA.

However it is important for politicians and the public to recognise that there are no regulatory silver bullets.

None of these new rules will replace judgment, both professional and political. You can’t regulate away risk, and nor should you want to, because there is risk in all innovation and investment.

None of these rules will replace the need for politicians and central bankers willing to call time on asset bubbles.

They will not replace shareholders and boards willing to challenge excessive incentives tied to excessive risk or unsustainable growth models.

They will not replace managers who know the difference between innovating and sidestepping the rules. And between genuine hedging and speculative trading - or gambling as we non-specialists usually call it.

Alistair Darling said last week that the banking revolution needs to start in the boardroom and he got some criticism for the apparent lack of radicalism in that suggestion.

But he is absolutely right, and it only lacks radicalism if the people in those boardrooms are not radical enough. If they lack a commitment to change or lack a vision of Britain’s long-term banking future, or think that with the urgency of the crisis behind us, the pressure or need for substantial change will pass.

I look forward to seeing the interim recommendations of Sir David Walker’s review of corporate governance in the financial sector and we need to use them to shape a debate about boardroom approaches to risk, to pay and to corporate strategy.

The role of the BBA

Angela, you personally and the BBA as an institution, have done a useful service in lobbying for a considered regulatory response to the credit crunch. We need to recognise that alongside the Turner Review, by far the most important part of that response is going to come from the EU.

I have always been a strong defender of EU regulation in this area. I think it responds to the reality of a single European financial market and to the need to have an agreed European voice in the debate on global prudential standards. Lord Turner is right that it is necessary and desirable and unavoidable.

But Brussels has to recognise that EU rules will affect the UK far more than any other European state. We have more skin in this game than the rest of Europe put together. We expect this to be recognised and while we will be working for stronger European rules, I want to make it clear that we will also be defending the UK’s interests. I am sure my friends in Brussels will understand and appreciate my message tonight.

So I want to urge you today to focus on Brussels. You need to be building sectoral alliances in other member states and all of us need to be pushing back against a knee-jerk political response, from the Parliament or from the Commission, in favour of reasoned argument. This is especially the case in areas like private equity, where an ill-considered approach risks making Europe an unattractive place for investors.

You are right to argue that while we need to look again at the way capitalization requirements reflect the assets on bank’s trading books, and the risks inherent in different banking models, not all liabilities carry the same risks. Currencies are not CDOs.

You are right to argue for a global approach to regulating financial services to minimize the risk of regulatory arbitrage. The ultimate test of the competitiveness of the UK financial sector is not the lightness of the regulatory touch, but the levelness of the international playing field.

I want to stress this - I do not believe that the competitiveness of the City can lie in being less regulated than anywhere else.

You are also right to argue that there is an important distinction between the setting of standards and rules internationally and the day-to-day supervision and execution of these rules and standards.

The UK pushed hard to have this argument recognised at the EU level, where the urgent need for new harmonized rules has to come with the recognition that because it is ultimately national taxpayers’ money on the line, it must be national supervisors executing the rules. It’s a basic principle of fiscal accountability.

Finally, and perhaps most importantly, you have been right of course to warn that there will be some kind of trade off between new rules, especially on liquidity and capital requirements, and the funds banks have available for lending in the rest of the economy.

This is critically important as the economy returns to growth, and the government is committed to ensuring that we strike the right balance here and in Europe, in respect of banks and other financial institutions, whose lending and equity we depend on.

If there has been one message from the BBA that has been driven home more than any other over the last year it is that these judgments must be based on sound impact assessments and analysis. You have urged rightly the FSA to do its homework.

But the reality is that the most powerful tool available to regulators and government in getting these judgments right is the data your industry provides. Three months after the Turner Review we still do not have the kind of data - not all of it - that we need, and you will have to build a compelling case. This is an omission, in my view, that needs fixing.

The next British economy

Let me say this in conclusion.

Today the government has been launching a prospectus for Britain’s economic recovery and renewal. It touches on a wide range of policy areas that will define the next decade in this country. Constitutional change. Further public service reform. Climate change. Our ageing population.

But it also sets out our plans for continuing to equip the UK to compete in a global economy through its knowledge, its innovation, our enterprise and our skills. The creation of a new department of Business Innovation and Skills, bringing those policy levers together in one place, is part of that wider vision of what a country needs in order to prosper in the twenty first century.

We often talk about the need to balance the UK economy away from financial services. But the economy is already a lot less ‘unbalanced’ than some people think.

Manufacturing actually accounts for a significantly greater share of UK GDP than financial services (7.6/12.6%). It’s always interesting when you tell French politicians this – they look at you as if it must be some kind of Anglo Saxon accounting!

We do need to keep investing in our basic strengths in advanced manufacturing and precision engineering, in science and biotech, in green technologies, in the creative industries - so that this balance is retained and strengthened.

But the point is that the financial sector, as well as being a major export earner in its own right, underwrites all these other parts of our economy. It is its banker, its insurer, its advisor, its lawyer. There is no British economy without our financial sector.

I know you don’t like banking being described as a utility, but long term, stable credit is as fundamental to our economy as electricity or any of our infrastructure in this country.

We certainly need bankers who don’t think it’s a slight on their dynamism or ambition to think that way.

Ironically, I think one of our biggest problems may be premature good economic news. When it comes to change and the changes this sector needs to take on, it may become harder to maintain the urgency of reform, especially internationally, as banks restructure their balance sheets and pay back government loans and the bonuses go up again and the economy returns to growth and the crowds go back to hating journalists and estate agents more than politicians and bankers.

Everyone’s a reformed drinker at the height of the hangover. The real test of commitment is when the headache clears.

But no one should doubt our commitment to using this window of opportunity to redesign our own and international financial standards and supervision.

Nor should they underestimate our commitment to a strong, international British banking industry. Just as they shouldn’t doubt the resilience and capacity for renewal of the industry itself.

There will have to be a change in boardrooms. For politicians and regulators there is going to have to be a lot more thinking outside of national and sectoral silos.

This is something we can and will achieve together for the long term future of the British banking industry and, therefore, for the future good of our economy and our country as a whole.