Changing the culture of competitive banking

What impact will suggested measures to prevent another crisis have on the global finance sector?

John Varley, chief executive, Barclays: Good morning. "What is the role of a socially responsible bank?" When things have gone wrong in our industry, when mistakes have been made - as they have - it seems to me that we should be thinking very carefully about the answer to that question. It looks something like this: a socially responsible bank will invest for the future; it will support appropriate risk-taking by its customers; it will run capital ratios that create confidence in the system; it will pay dividends to its shareholders on the profit that it makes; it will pay due tax to its revenue authorities and it will run its affairs on the basis that there is no safety net from the government, from the taxpayer or from the central bank. Banks can play a constructive role in economic generation if they are well run, but they can be a destructive economic force if they are badly run.

Bank boards have responsibilities to manage their affairs in a way that ensures they are socially useful. To pass the test of accountability, the pursuit of profit must not come at the expense of society. The bank needs to screen its activities to test whether it makes a useful contribution to society. We have an obligation to be a responsible employer, to be a responsible lender and to be a responsible investor. Banking boards also need to understand the obligations that go with running a successful business. By that I mean that we need to make certain we use our profits productively, and so that our contribution to society recognises society's contribution to our success.

Today, there are two key tests of appropriate responsible behaviour: what and how we pay, and what and how we lend. We should be held accountable for those two things, subject to obeying the law, to abiding strictly by the regulations that are imposed on us by our regulators, the Financial Services Authority (FSA), and to providing services that are relevant and good value to the customers and clients we serve. Subject to those things, the arbiters of our conduct should, ultimately, be our owners.

We must do everything in our power to make sure events like those that have happened in the world over the course of the past three years never happen again. We owe it to society, and it requires change. We completely accept that and it means banks taking their medicine.
However, we have to strike a balance between creating a system in which risk is contained and creating a banking sector that is fit for purpose. By fit for purpose, I mean that the critical role of banking in society is the facilitation of the taking of appropriate risk by its customers and its clients. The important words there are "appropriate risk" and "facilitation".

What sort of risks am I talking about? It could be the risk of saving for the future, of buying a flat, of borrowing for university education, the risk of starting up or taking over a business, or it could be the risk of launching a big programme of government gilt. Customers and clients look to their banks to help them take those risks. The world needs to grow at about 4 per cent per annum if we are to create more employment or to alleviate poverty. That requires risk-taking by governments, by businesses and by households around the world. Society needs banks to facilitate the taking of that risk. Those should be healthy banks, competitive banks, but they should be responsible, accountable banks.

Alex Brummer: Thank you, John. We will hear from you again at the end. I will introduce the panel and each will make some introductory remarks. I am Alex Brummer and I am chairing this session. I am the City editor at the Daily Mail.

We have with us Lord Myners, Financial Services Secretary to the Treasury. He has been in the vortex of what has occurred in the banking sector in the past 15 months and has been very outspoken on the recent behaviour of the banks, particularly on bonuses.

We have Mark Hoban, the Tories' shadow financial secretary to the Treasury. He has a broad economics background, an economics degree and an accounting role, so he should be able to work through the numbers well.

We have Colin Breed who is a member of the Treasury select committee. Colin is an experienced businessman, a former banker himself and one of the few bankers sitting in the House of Commons, so he speaks with expertise. He has a banking qualification, has been a stockbroker and an entrepreneur before he was an MP, and he represents the Liberal Democrats.

Paul Myners: Thanks, Alex. Thank you to the New Statesman - I tried to buy it two or three years ago and it is always a delight to be at one of their events. Also, thank you to Barclays; Barclays has done a lot to stimulate discussion and I think it is rising to the challenge of a debate about the future of banking and the challenges we face. Over the past year there has been plenty of attention given to looking forward, and with good reason. In October 2008 our banking system failed, sending our economy into deep recession; the cost in terms of lost jobs and lost wealth has been considerable. So it is right that the public, the media, the government and the industry have undertaken a vigorous public debate on the causes of the crisis, and that debate must continue.

Taxpayers have been justifiably angry to see their money spent rescuing institutions that became rich by taking reckless gambles. There is a perception that there is something unfair about the standing behind the banking system and bankers, but not standing behind people working in other industries that have suffered the consequences of the economic recession. The government, including myself at times, has been frustrated with the level of resistance to reform that we have seen from the banking industry and bankers. The vast majority of bankers were not to blame for the recklessness of a few of their peers and have been saddened as the reputation of their profession has been tarnished. We should not underestimate the ability of this anger and frustration to distract us from the task at hand. We must turn it into something constructive.

Collectively, as government and industry, we must work to rebuild a sound and responsible sector that will drive economic growth and jobs, free from taxpayer support. Government has been busy with regulatory reform, including domestically through the new Financial Services Bill, in Europe and with our G20 partners. Banks are rebuilding their capital bases and restructuring their business. They need to improve the quality and quantity of bank capital to protect depositors, the taxpayer and the system, as a priority.

Businesses and workers have a pressing interest in seeing new drivers of growth get the finance they need. Shareholders, the ultimate owners of the banks, now have, in the form of the Walker review, a manifesto for engagement and stewardship; our banks should not be ownerless corporations. There is a role that shareholders should play that they have not been in the past.

We make no apology for the tough action we have been taking to end the culture of risk-taking and excessive rewards that damaged our banking system. Risk is critical to banking, but we need to focus on ending the culture of poorly identified and badly managed risk. It is time for our discussions to focus on the future of finance; the anger must be set aside so we get ourselves into a more constructive mindset. Of course there will be some difficult challenges ahead, including over bonuses, but I am confident that these can be addressed successfully with regard for fairness and equity.

On the issue of bonuses, the complaints we are seeing from well-paid City workers about the new bonus tax are directed at their employers rather than at government. It is a matter for boards and shareholders to decide if payments should be cut. Government has changed the economics of the choice but the choice remains with boards of directors and with shareholders. We are striving to achieve soundly managed banks and markets that support and enhance the generation of wealth in our economy. This will support lending to businesses, opportunities for homeowners and security to savers. A banking system that is economically and socially useful is an international asset which we want to promote and need to succeed. A vibrant banking sector is an important precondition for future economic growth. We must learn the lessons of the past decade to rebuild
a sector that can innovate successfully, manage risk appropriately and create long-term prosperity.

Mark Hoban: What we have seen over the course of the past two and a half years is a breakdown in trust between the wider financial services sector, banking in particular, and the rest of the country. There is a big divide between what the Americans would call Wall Street and Main Street. Taxpayers are genuinely horrified by the cost of the banking bailout, the guarantees they have had to stand behind, the indemnities and the direct investment in Lloyds and Royal Bank of Scotland (RBS). One of the challenges that banks, policymakers and regulators need to face is, "How do we rebuild that relationship between the financial services sector and the broader economy and the country as a whole?"

There is a concern that the financial services sector will come under much greater pressure, scrutiny and challenge, and, given how important the sector is to the economy as a whole, that is the wrong place to be. I want to make three points about what we need to do to change the environment in which banks and the financial services sector operate.

The first one is to look at the offer to the small and medium enterprises (SMEs) and to retail customers. What we have seen in the past two and a half years is a much greater concentration in the banking system. Lloyds took over HBOS, there is less competition in the building society sector, and there is potential for banks to have a disproportionate amount of power and to offer a suboptimal deal to their customers. This is why we have argued for a competition review of the banking sector and why we have said we would use our stakes in the banking sector to open up the market to create more competition and greater challenges to the existing banks.

The second point is to make sure the right capital structure is in place. This operates at two levels: we have argued for a long time that we need to see proper counter-cyclical capital in place, that the Basel Agreement exacerbated both the upswing and downswing of the cycle. In Spain, banks have come through in quite a strong position. The Spanish central bank opted out of Basel and produced counter-cyclical capital requirements, which is good for individual banks but also for the wider economy.

When discussing the next evolution of Basel and the capital-requirements directives coming out of Brussels at the moment, it is important to ensure that capital is proportionate to the risk inherent in the bank's business model - that it looks at size and complexity and makes sure there is capital allocated to deal with those aspects. Each of the directives coming from Brussels will be defensible individually; the concern we need to address is: "What is the cumulative impact of these?" Are we going to be in a situation where banks' capitalists say that either there is an appetite to fund that from investors or that the economic impact of that bank capital is such that it acts as a break on the economy? While that capital may make for stronger banks, it may lead to a weaker economy.

My third point is about the regulatory architecture. In our paper, back in July, we set out a plan for sound banking, with some significant reforms to the UK regulatory architecture. We argued that the Bank of England should act as a macro-credential regulator; it should also take on the responsibility for micro-credential regulation, particularly in the banking sector. We would create a new "Consumer Protection Agency" to deal with the credential regulation of smaller, less systemically important sectors and give a better deal for consumers. We need to get the regulatory framework right. The capital imbalance that built up in the global economy over the past decade had a major impact on the shape of the crisis. Lord Turner acknowledged in his review that tackling this issue fell between two stools. It was not the responsibility of the FSA, and the banks did not have the power or responsibility to tackle it.

Last week, Colin and I had the pleasure of taking evidence, as part of the Financial Services Bill. One of the government's flagship reforms is to create a Council for Financial Stability. The minister, Ian Pearson, was very clear that we were all equals in the committee but, when he spoke to the FSA and the banks, a slightly different picture emerged. The FSA said it had secondary responsibility for financial stability and the banks said that, ultimately, the Chancellor is in the lead for these issues. So we felt that we have as confused a structure now as we had under the old regime. More work needs to be done to get this right. We need to get regulation, capital and competition right if we are going to re-create trust among the public in financial services.

Colin Breed: I want to make some comments about three issues: banking, regulation and corporate governance.

Some years ago, when I was responsible for compliance in a small banking company, I had to undertake the usual MOT test for the Bank of England: going to the supervision department. We sat in this airless room in the middle of the bank, surrounded by oak panels and various homilies. I can only remember one and it said: "There are no new rules in banking, you just have to relearn them every ten years." Perhaps that ought to be in every boardroom in every bank in the country, because there are five basic principles and rules that have persisted for decades, if not centuries, and they are as applicable today as they have ever been.

One is capital adequacy; banking is probably the most capital-hungry business you could undertake, and preservation and accretion of capital is at the heart of any banking operation. Second is liquidity ratio - the ability to have liquid assets. Those two are the principal rules of any banking industry and it seems we sometimes forget them.

Third is to understand and manage your risks; if risks are understood they can be better managed, giving you a better chance of success. Fourth, all business is personal - know your client or your customer. Far too often we undertake business too remotely and do not understand who we are doing business with. Fifth, turnover is vanity, profit is everything; just growing for the sake of growing, buying things to prevent others from buying them, is a vanity that cannot be afforded. Profitability should be at the heart.

Going on to regulation, I agree with Mark that the evidence sessions in advance of our consideration of the Financial Services Bill did not provide
us with the security that everything was going to be sorted out in the bill. I feel regulation should pass four tests, which I will be applying to the various regulations introduced in this bill. Regulation should be appropriate, practical, enforceable and proportionate.

Corporate governance has been given greater profile recently but it needs to have very clear objectives. Everyone needs to possess accurate and timely information, from risk committees or from auditors. They need to be confident to challenge management and ask: "Why are we doing this, what tells you that we should be doing this?" To be the grit in the oyster, if you like, that makes people uncomfortable when they have to answer the questions.

Corporate governance ought to be constantly refreshed - we need new people. Far too often people come on to boards and go native, when they are there to challenge - a confident friend who is there right the way through.

Alex Brummer: Mark raised splitting regulation in some way, between macro-regulation for bigger, more complex banks, and a consumer regulator for some of the smaller institutions. Where would you draw that particular line?

Mark Hoban: In our paper, we argued that, if you give the Bank of England powers of macro-credential regulation, to understand the trends in the market and have responsibility to tackle those trends, it seems logical to extend its remit to cover the micro-credential regulation of deposit takers. In that way, they can regulate banks and other institutions' safe deposits in the knowledge of some of the trends in the wider marketplace. They can also inform the wider marketplace based on the work they do to regulate individual institutions.

At the other extreme, you have a raft of high-street independent financial advisers (IFAs) - I think there are 19,000 businesses in the FSA small-business division - and it is right that they should be regulated by the two protection agencies, where extending the risk is less important. You want the bank to focus on the most important sectors, rather than be distracted by the regulation of the IFAs.

Paul Myners: I do not think there is any evidence from across the world from which we can draw comfort, that one particular structure of regulation has proved stronger and more effective than another. The most important issues are around judgements, behaviours and conduct. Any system can work providing the people are appropriately skilled and clear as to their objectives.

We believe there is real merit in keeping the responsibility of regulation and supervision with the FSA, separate from the Bank of England's primary responsibility, monetary policy - although the Bank has always had a responsibility for financial stability and that has been written larger in the upcoming Financial Services Bill. When I come back to behaviour, I also come back to corporate culture. The Bank of England is a small, very intellectual organisation, primarily focused on making critical judgements about interest rates and the quantity and price of money. I am not sure that that institution is going to be able to take on responsibility for bank regulation of complex banks that were too complicated to be run by the people paid to run them. It is an inappropriate risk to take at this stage.

Alex Brummer: Colin, regarding this new Council for Financial Stability, do you think it is the right replacement for the tripartite of the Treasury, Bank of England and FSA, or do we need a single point of leadership when there is a crisis?

Colin Breed: It comprises the same three people with a different name, and perhaps to a certain extent it formalises something that has taken place - the publishing of minutes and such. It will be chaired by the Chancellor and, if there is clear evidence that one person has to take the decisions and responsibility at certain crucial moments, that will be a good thing, but that is not clear at present. We hope to make it clearer during the committee stages of the bill. The select committee went to three European capitals the week before last and, in at least one of those, their financial stability council is chaired not by their finance minister, but by the governor of their central bank. Different countries have different views, but it has to be clear who is directly responsible. What was not clear to me was whether this new Council for Financial Stability was very much different from what we had before, which was not quite up to the job.

Alex Brummer: I will now take questions from the floor. Neil Chrimes, from the office of the Lord Mayor of the City of London.

Q. Neil Chrimes, office of the Lord Mayor of the City of London: I was very pleased to hear the panel's focus on trust and rebuilding relations. My question concerns last week's pre-Budget report (PBR) announcement by the Chancellor - specifically the payroll tax on bonuses. I would like the panel's views on how this will affect the future competitiveness of the City and whether, unless introduced in concert with similar methods in other major competitive financial sectors, we risk undermining the contribution that this significant sector can make to the UK economy.

A. Paul Myners: We should not lose sight of the fact that the banking industry has received very substantial taxpayer support in the form of protecting counterparties, through liquidity. All our major banks made major drawings on central bank liquidity schemes, including the Bank of England, the European Central Bank and the Federal Reserve Bank in the US. Most of them have issued instruments with government guarantees for which they have paid a fee. They have also benefited from what are reasonably benign conditions for investment banking, as
a consequence of quantitative easing and other government policy. So, in that situation it is not unreasonable for people to say that banks should put some contribution back. Our estimated tax from this proposal is very approximately £550m, a modest sum comparatively.

Alex Brummer: The Financial Times estimated £4bn or more being raised.

Paul Myners: Well, it will depend on behaviours. It is a tax dependent on decisions made by banks' boards of directors and approved by their shareholders. If banks pay substantial bonuses, then it will lead to larger amounts of tax. If they change their behaviours and prioritise conserving capital, the banking system will be strengthened. Banks need to acknowledge that there is global pressure to increase capital over the next few years - not immediately, as it would be inappropriate for economic recovery. Their priority has to be to retain capital to support future lending and to give greater assurance and comfort to depositors. It will be a matter for the boards of directors and their shareholders to make a determination as to how much bonus they want to pay.

Alex Brummer: And the fears that this might lead to an exodus from London?

Paul Myners: We want London to continue to be a critical and global financial centre. The work that the Chancellor commissioned with groups chaired by Win Bischoff and Michael Snyder and others was about enhancing London's role as a financial centre. Importantly, the Bischoff group was, in particular, talking about London in partnership with other centres. We need to remain calm. Much of what is being said in the press is targeted at people making decisions in banks rather than the government. They are saying "We demand our bonus", but people find that very odd. We are talking here about large sums of money - more than £25,000, which is more than national average earnings. We are probably talking about a tax that only begins to affect the top 5 per cent of national earners. There is a broadly held view that there is a need for some payback and restraint here, and I am hoping that this step will lead to banks and their boards of directors revisiting the questions.

Many of these bonuses are being paid without sufficient discrimination in terms of actually rewarding talent. Much of the "talent" that has been rewarded has been for people who are doing a good job but are not extraordinarily talented. A more discriminating approach to bonuses will see boards and senior management identifying those who really have talent and not allowing a windfall benefit to accrue to others.

Boards also need to ask: "What can we do to reduce our dependence on these people? What can we do to reduce the constant pressure we have about remuneration?" They should develop more strength in depth of resource, institutionalise it and make it less dependent on individuals. We need a tighter grip on remuneration. It has proved extremely difficult for our senior bankers to develop a good code of practice for high-level remuneration.

Alex Brummer: Mark, would the Tories have imposed a one-off windfall tax?

Mark Hoban: We would not oppose that measure. In October, in a speech in Manchester, George Osborne said that we were open to the prospect of a windfall tax. The government got itself into a real mess over this, though. We suggested a couple of months ago that bonuses be paid out in shares, rather than in cash, to enable banks to build up their balance sheets and lend more money to the business sector. The other thing that has happened, like other aspects of the PBR, is that it has all rather unravelled since the day the report was delivered. We do not know whether it is going to affect insurance and stockbroking units within banks. If we think a windfall tax is appropriate, let us make sure that it is well thought through. It sends out the wrong signals that UK tax policy was made on the hoof and not in a deliberative fashion, understanding exactly how it will work and what the implications are.

Alex Brummer: Do you think bankers are packing their trunks or not?

Mark Hoban: The message I pick up, from the City and from wider business, is about the importance of a tax system in ensuring that the UK is a good place to do business. There is growing concern, not just about the headline rate of taxes, but also about tax policy. That is driving some businesses to think about whether they should be domiciled in the UK. We are already seeing a number of businesses outside the financial sector, as well as inside, moving overseas because of the tax environment, so we need to get tax right to remain well placed to do business.

Alex Brummer: Colin, are your former colleagues being badly treated?

Colin Breed: Some have brought it upon themselves but the vast majority probably have not. Of course, you can get the figures to tell you whatever you want. I do not think the banks made a clever decision, bearing in mind the decision of the Supreme Court on bank charges, to suddenly have another go on this and I think they will pay for it in the future. Others will take advantage of that very fact. The remuneration policy is part of the business model and should be regulated by the FSA, not legislated by the government. A windfall tax, bearing in mind the taxpayers put a huge amount of money into the banks in one way or another, does not seem unreasonable to me, at least on a one-off basis. I love that quote about Goldman Sachs doing "God's business", but what I would remind you of is that, in the parable of the talents, Jesus condemned those that got money and buried it in the ground; the one that did the most with it was praised.

Alex Brummer: Peter Montagnon, you are director of investment affairs at the Association of British Insurers. I wanted to ask you about Paul
Myners' point on whether remuneration committees and shareholders have not been strong enough in exercising controls so that bonuses have got
out of control.

Peter Montagnon, Association of British Insurers: I thought I had just come here to listen! The truth of the matter is complicated but one principle that arises from this, which shareholders will have to work at, is that, if bankers are going to keep the bonus pots and then pay tax on top
of that, that will take money out of shareholders' pockets. We will have to look at that very carefully.

I am not saying that there will not be justification for banks paying in every case, because there may be genuine competitive issues, but we will need to look at that. In other areas, we are in support of restraint.

We are supporting the FSA claim; we have been supporting the G20 principles; but we do not support the idea that you can go around tearing up existing contracts, because that undermines the rule of law on which the financial sector depends. Nor would we support the idea that the government or the FSA should summon shadow directors. There will be limits on either side but, within those limits, looking at it on a case-by-case basis, we will be urging restraint. We need to bear in mind that the long-term competitiveness of the City depends on the ability of these businesses to generate long-term profits for their shareholders. You cannot tip the baby out with the bathwater.

Paul Myners: I am delighted to hear Peter say that. I think there has been a ground change in the attitude of institutional investors over recent weeks to becoming much more involved in engaging issues, and defining where they should get involved, which is not to micromanage but to be appropriately challenging around some of these bigger issues. I am much encouraged by what Peter said and what I see UK Pensions and Investments and the National Association of Pension Funds and others doing.

Tearing up contracts is a phrase with a certain media resonance! There was never any suggestion that contracts should be torn up. What we are saying is that, in future, contracts would have to be drawn up with certain specifications. On the day this was announced, I had to be very clear that the government would not expect companies to aggregate contracts. Contracts will be honoured. Indeed, in the bonus-tax arrangements announcement made on 9 December, we specified again that, where bonuses are a contractual obligation, they remain so - however unattractive we find that. The reason we did not introduce a windfall tax is that it would have the opposite effect on rebuilding capital, which is so important. If you put a tax on banks, based on their profitability or their balance sheet, it would erode their capital base rather than build it. Our proposal, particularly if Peter Montagnon's point is accepted by banks, will actually serve to enhance the capital base of banks.

Alex Brummer: Jon Snow has a question.

Jon Snow, journalist: At the risk of upsetting a dangerously comfortable meeting, I would like to follow up on John Varley's excellent opening which warned that the pursuit of profit must not come at the expense of society. I am wondering what society's recourse is when it does? When, in the words of Paul Myners, "reckless gambling" takes place, what recourse is there for society? I note that nobody has gone to jail yet and I note there have been no criminal negligence actions. If the banks had not been bailed out and there had been rioting in the streets, I find it impossible to believe that the force of law would not have been used to arrest a good number of people and put them in jail.

I would like to hear about the future regulation of banks and the future arrangements to protect people from the pursuit of profit that comes at the expense of society. What measures are being brought in to ensure that the full force of the law will be visited upon people who recklessly gamble at the expense of their shareholders, institutional investors and customers?

Alex Brummer: Colin, why have bankers not gone to jail? Why have we seen the justice system so slow in this process?

Colin Breed: If someone has actually transgressed the law then, of course, they should be held accountable for it. I think when we talk about the pursuit of profit at the expense of society, the question is: to what extent are you driving the pursuit of profit? I heard what Mr Varley said, but he will recall that what the Treasury select committee was looking into was the means by which banks were not only undertaking complex tax avoidance issues but actually selling tax-avoidance schemes to others to help them avoid tax - I did not say evade, but avoid. The pursuit of profit is as much about tax avoidance as anything else but, if that tax avoidance is at the expense of society, perhaps it ought to be reconsidered. People need to recognise their own responsibilities to society and the way that they actually manage that is probably not capable of legislation.

What we have done over recent years is to impose ever more regulation, in a formal sense and a legislative sense, which has eroded or completely removed what we used to have as self-regulation. Most businesses, including banks, had an understanding 25 years ago, when I was involved, about what their roles were and what they did, and they regulated themselves. However, once you impose formal regulation, people say: "It is not being regulated, therefore I can do it." It's a bit like saying, "As long as there are no double yellow lines, I can park wherever I like."
People have to understand that there is self-responsibility and self-restraint. We have eroded self-regulation over all sorts of sectors.

Mark Hoban: In the US, there appears to be a much more visible high-profile approach to tackling financial crime than we have in the UK. The enforcement mechanisms used by the FSA are private, so you do not hear about investigations until a conclusion is reached. We do not know what action the FSA is taking against people who may have infringed its rules during the financial crisis.

Alex Brummer: Would you like to see people kickingdown some doors and carrying people off for questioning?

Mark Hoban: We need to ask some questions about whether the lack of transparency around enforcement is appropriate. A number of consumer groups are concerned about whether the FSA should be naming and shaming firms where there is a record of complaints. However, there is also an issue about powers. The prosecution of financial crime in the UK is quite fragmented. You have the Serious Fraud Office, the FSA, client responsibility, and City of London Police has responsibilities, too. Ken Macdonald, the former director of public prosecutions, raised the question earlier this year about whether or not we should have a single financial crime prosecutor. Would that lead to more effective enforcement of breaches of criminal law? That is something we are looking at currently.

Paul Myners: I would like to answer Jon's question in three separate points. First, we need to keep the balance right in terms of protecting society from the banks and their wrongdoing and recognising that a strong banking system is a critical element of an effective society and a growing economy. Banks play a very important role in making credit available, providing safe and secure homes for deposits and as a reliable money-transmission mechanism. A good banking system is a national asset and, for us, it is an international asset that we should cherish and seek to protect and grow. I have to tread carefully on the issues of regulatory actions, but there was a reference in the Lloyds Bank rights issue document to the FSA looking into conduct in relation to HBOS.

As Mark says, it was felt when the Financial Services Act was passed that this would best be done in a way that was not publicly disclosed. I know this has been challenged around things such as mortgage conduct recently by the select committee and the Treasury, and perhaps this is a matter to which others will return. There is work going on, but, Jon, we cannot send people to prison unless they have committed a criminal offence. Mark drew attention to something George Osborne said in Manchester. Let me draw attention to something Gordon Brown said in Brighton: that there should be no doubt that anybody who has committed any wrongdoing, if it is of a criminal nature, should be prosecuted; and, at the very least, those who have shown incompetence should no longer be judged worthy to sit on the boards of public companies. The biggest issue here was misjudgement and failure of competence rather than a breach of law.

Finally, how do we protect society and the economy from the banking system? Well, more capital; better rules on liquidity, pursued internationally through Basel and the G20; enhanced governance of the sort we have talked about with David Walker; enhanced shareholder engagement; the new recovery and resolution mechanisms that we are putting in place, which include the "living will" [plans for how banks should be wound up in case of bankruptcy]. Also, some of the ideas floated in the Treasury's discussion paper Risk, Reward and Responsibility: the Financial Sector and Society consider such issues as the internalisation of risk through deposit guarantees and risk-premium transaction taxes, all of which we think are areas worthy of global debate.

Alex Brummer: Alistair Asher, you have a question on living wills?

Q. Alistair Asher, Allen & Overy: I was struck by the suggestion that bankers be entrepreneurs and not speculators, which has echoes of Glass-Steagall [see page 10]. My question is: will the living-will regime introduce a Glass-Steagall regime via the back door?

Alex Brummer: I think you are referring to the governor of the Bank of England's suggestion that perhaps the utility elements of the banks be separated out from the casino elements of the banks, and the best way of getting there.

A. Mark Hoban: We have expressed our support for the concept of separating utility banking from other, riskier elements of banking, and that was set out in our policy paper. It is difficult to do that on a country-by-country basis; it needs to be by global agreement. I am not sure the living will
is going to be the mechanism that forces a Glass-Steagall through the back door. I think banks will think about how they are structured and the recovery and resolution elements of living wills.

I suspect there may be a point where the increased capital that banks will need to hold against riskier forms of activity may prompt institutional shareholders to ask whether they want to invest in a diversified bank or utility bank, and are happy to invest in a bank that undertakes riskier activity. So there may be a number of pressures that might move banks towards a de facto Glass-Steagall, through response to shareholders and market conditions. I do not see living wills driving us to that point alone.

Colin Breed: I broadly agree with that. I am not a great fan of living wills in recovery. I can see that businesses should have some understanding of how their business model can operate, and the risks they run in the proliferation of services and businesses, and ensure that any one particular activity should not euthanise the whole body. I have great doubts about whether that should be formalised in some way through the FSA. What is a recovery resolution? Is it two pages of A4, saying if this happens we will all pack up, or is it 200 pages of a blueprint that will seek to identify every possible eventuality and that will be a guidance to everything they do? I do not think we have really thought this through.

Businesses ought to understand that their business model and practices need to contain an element of understanding that, in the event of an activity being subject to potential failure, they should have a means by which it can be addressed at an early stage, and hopefully not infect the whole body of the business. I do not have a great deal of support for that.

All I can say on Glass-Steagall is that my boss, Vince Cable, is completely wedded to it, and as one of the people on the same Treasury team as him, "I don't."

Alex Brummer: Alistair Asher, do you think there is a legal way of doing this? You represent one of the big City law firms; do you think this is something that can work?

Alistair Asher: We are discussing with clients exactly what they need to do, so the banks are addressing this.

It is not clear what needs to be done, other than the ultimate purpose of having a piece of paper somewhere that describes what is within the bank. If there were a clearer understanding of what is intended to do, it would be easier to prepare.

Alex Brummer: So what advice are you giving clients at the moment?

Alistair Asher: That they should wait!

Colin Breed: To come back on that, the very last question I asked in the evidence session last week was to someone from Linklaters. I said to him, "On a scale of one to ten, how is this Financial Services Bill a benefit to lawyers?" He said, “I hesitate to say it, but it is excellent."

Alex Brummer: Do you think that is the case, Alistair?

Alistair Asher: I certainly hope so.

Paul Myners: We rejected Glass-Steagall, and I think the separation of the utility from the casino would do more damage to the UK as a financial centre than anything that has been discussed earlier.

Alex Brummer: Well, the governor of the Bank of England seems to favour it in one or two of his speeches.

Paul Myners: The governor's position has evolved and it may continue to evolve, but, if you look at his answer to a question from the select committee, from Viscount Thurso in the early summer, he seemed to have a rather different view.

It is not practical, first, because it is not easy to make a simple distinction between the narrow and the broad; and, second, even if you can, we have seen evidence that the narrow can suffer contagion from the broad. It is not possible to purely insulate deposit-taking institutions from the failure of a large investment bank. Third, it implies that all the risk lay with the broader banks, but it did not. Some of the biggest failures were the narrower banks. It is not our intention that living wills should be a mechanism for enforcing some Glass-Steagall outcome, although that capital may well mean that certain activities currently conducted by banks may no longer be as attractive for them.

On the question of whether it is two pages or 200 pages, I suspect it is going to be a lot more than 200 pages. There are trial projects going through the FSA now with four banks, but, speaking personally - from being involved in the resolution of failing institutions - probably even the Dunfermline Building Society would have needed 200 pages if it had had a living will. We found no preparation at all for possible failure and it is interesting that regulators are also beginning to adopt the mentality of the living will. The FSA is inviting banks to contemplate: "What is the worst thing that could happen and how would you cope?" That is at the heart of the concept of the living will.

The living will obliges institutions to contemplate where the biggest risk of failure lies and how they can isolate that failure in such a way that it does not damage the whole institution, let alone place unreasonable claims on society.

Alex Brummer: If RBS had had a living will would it be 84 per cent owned by the government now?

Paul Myners: If RBS had had a living will it would not be 84 per cent owned by the government now. It would have been possible to separate out parts of the business in such a way that was not possible in the way it was structured.

Alex Brummer: So, instead of owning 84 per cent of it, why do you not separate out the good bits and keep the bad bits? Why keep it as one single entity wherein government has huge equity exposure?

Paul Myners: It is now under much better management, with a much stronger board that is capable of independent challenge and an almost completely re-engineered senior management team. Already, there has been a very substantial downsizing of the RBS balance sheet - reduced by 20 per cent from its peak.

So, that is addressing these issues, but we do want to return RBS to genuine private ownership, and we are going to do that. We want it to be a commercially successful, profitable organisation, earning a good return on equity from doing good business with strong management, and we can do that with the existing structure rather than splitting the bank into smaller units.

Alex Brummer: Mark, is it wise to have the Royal Bank of Scotland trying to trade its way out of trouble, rather than split it into sensible, manageable units?

Mark Hoban: It is quite a complex issue because the taxpayer has a strong interest in returning RBS to the private sector and covering its investment in it. There is a long-term question about the structure of the banking sector and how much competition there should be. We have said that we need to see a competition review taking place in the banking sector to take into account the concentration that has taken place over the course of the past two and a half years, to ensure there is a good deal for retail customers and SMEs. That may well dictate the structure of banks going forward.

We have been very clear in saying that we should use our stake in RBS and other banks to look at the structure of the banking market, but you need to do that in an informed way and that is why we argued the need for a competition review.

Paul Myners: Would you require the major banks to be broken up, Mark, and what would be the test in determining whether they should be broken up, regarding the fact that banking in the UK is not significantly different, in terms of concentration, from many other economies?

Mark Hoban: There are ways of encouraging new entrants into the market and using our stakes to encourage competitiveness.
Tesco is emerging as being interested in the retail market. You have other people in the retail space looking to expand their presence in financial services, so there are plenty of ways to encourage competition in the marketplace and diversity of choice. What we do not want to see is consumers being penalised because they do not have choice as they cannot switch their accounts from bank to bank. You need to have that choice to keep banks on their toes and to make sure it is a good deal for consumers.

Alex Brummer: Colin, should RBS be run as it is, or broken up? Should we be gambling with taxpayers' money in the way that we are?

Colin Breed: The problem with RBS and such is that they have confused objectives, particularly with UK Financial Investments. Is UKFI there to get the value for that business back as soon as possible by sailing into the market, or is it to be used as an instrument of government to increase lending to the SME sector, for instance? If you lend more money, then you will not be putting capital back and therefore delaying the opportunity to put it back in terms of the market. If you put more money into what are still pretty choppy waters, that may produce more poor lending in the future. There are terribly mixed objectives. In a company the size of RBS, if a shareholder owns 84 per cent they could very quickly own 100 per cent and have complete control.

UKFI and RBS are in an almost impossible position; on the one hand, they are trying to improve their capital position and downsize their balance sheet; on the other hand, they are being exhorted to lend money to SMEs in order to improve the economy and everything else. It is a complete and utter mess. Let us decide what they are supposed to be doing and let them get on with it.

Alex Brummer: There is something in the Tories' proposal about the Competition Commission inquiry, when you consider that Lloyds Banking Group has huge shares in the mortgage market, the current account market and the deposit market in Britain.

Colin Breed: The problem with the Competition Commission is that it has allowed an over-concentration in the banking industry over a long period of time; this has not just happened in the past couple of years or so. It was felt that, if you had a smaller number of very large institutions they would be easier to regulate and have more stability. Of course, at the end of the day, they were not easier to regulate and were subject to the instability we have now. Diversity and the sort of strength we had when we had small and medium sizes of businesses actually provided a far better model for the UK financial services industry than what we currently have, which is myriad smaller ones, half a dozen big ones, and nothing in the middle. We have to recognise that we need to try to get some new entrants in, and take apart some of the bigger ones so they are easier to regulate and provide less systemic risk. Overall, they will give us a broader and better provider for the economy than currently is the case.

Alex Brummer: Paul, do you think the Competition Commission inquiry is a good idea or not?

Paul Myners: No, I do not think it is necessary. We are broadly in agreement that we need more competition and regularly meet with people such as Tesco and Metro Bank, and banks from elsewhere in the EU that are actively considering increasing their involvement in the UK or moving into the UK for the first time. I recently met with a bank from the southern hemisphere with similar ambitions, so we are doing all we can to facilitate an increase in competition.

We have taken a number of steps, for instance, making it easier for customers to move their bank accounts from one bank to another. There is a general perception that it is still extraordinarily difficult with standing orders and direct debits; but it is much easier than most people assume. We must continue to force pressures that will increase competition, but there is already a lot of competition in the UK banking sector.

Going back to Colin's point on UKFI, I do not think there is an inherent contradiction there. UKFI is a shareholder and behaves as an informed, engaged, long-term investor. When it comes to setting objectives for SME lending, for instance, the Treasury has set those objectives and I am very happy with the way that has developed. It is not just Lloyds Bank and RBS that have set themselves business-lending targets - other banks have done so.

Other banks have published charters and ending commitments, and I think the banks are responding responsibly to making credit available to businesses and SMEs. I am increasingly persuaded that the decline in lending to SMEs is largely a function of demand rather than supply. The supply and willingness to continue to supply credit is very strong.

Alex Brummer: I think you should see some of the Daily Mail's postbag.

Paul Myners: When I arrived as a minister, Alex, I inherited 3,600 unanswered letters from my predecessor and I receive a lot of letters as well. The letters I am getting more recently have been less about the availability of credit than the cost of credit, and I think it is very commendable that banks have been explaining how they price credit.

Alex Brummer: Keith Cuthbertson, you have a question on corporate governance.

Q. Keith Cuthbertson, Cass Business School: You have been talking about what will happen in the longer term and I suppose I am worried about what will happen in the longer term when all this goes away. Because finance is intrinsically boring, we will have to rely on the same people who failed in the past. For example, if you look at board remuneration, someone such as Sir Fred Goodwin, or Stephen Hester, these contracts are extremely lax. It is very easy to be paid a lot of money.

If you look at the contract of Sir Fred Goodwin, besides his salary of more than a million, if he beat his competitors' stock return by 0.001 per cent - he can do that with a coin flip - he then gets a 25 per cent bonus. When you look at the numbers in the way that he was paid, there is a 30 per cent chance, even if he has no skill whatsoever, that he will receive an extra 30 per cent.

It seems to me that relying on corporate governance as it has been in the past, with what the general public sees as an old-boy network, is not going to work. You need something much more vigorous and on the consumer side in the long term.

I have suggested something along the same lines as NICE [the National Institute for Health and Clinical Excellence], called "NIFE"- the National Institute of Financial Excellence, which would really try to keep a handle on both the politicians and the FSA. There is a lot of evidence out there about how you should run bonus systems and it is clear to me that these boards have not being doing it at all. It is also true that "NIFE" could do lots of other things.

Alex Brummer: So an internal whistle-blowing system, is that what you are proposing?

Keith Cuthbertson: Yes. There is no reason why such a body should not put forward a list of eligible names, with eligible qualifications, in order to be an independent voice on the bank board, who could be a whistleblower. The reason for this is that the taxpayer is de facto underwriting the banks.

I do not need to be on the board of Rolls-Royce because, if it goes under, the shareholders take all the hit and, by and large, the taxpayer does notstep in. It would be nice to have "NIFE" to apply to the bankers' broad shoulders when all this goes away.

A. Mark Hoban: The focus at the moment is very much on the banking sector, on regulation, on corporate governance and remuneration, and we have to make sure that, before the focus moves off to something else, we have the right regime in place. We must put in place the long-term reforms that we need to minimise the chance of a recurrence of a crisis on this scale. There is no single magic bullet for this. Yes, you need to have reforms on corporate governance, remuneration, regulation. We need reforms on the role of the FSA and the Bank of England; we need action on a European and global level; there is not a single, simple solution to this.

You are right, the taxpayer is now in a situation where there is a de facto guarantee and we need to work out what we can do to move away from that position. I was interested to hear Barclays' president, Bob Diamond, saying recently that no bank should be too big to fail. I thought that was a very important recognition from the banking sector that we need to move away from this position.

Colin Breed: It comes back to what I said earlier on: we need to be able to challenge. Corporate governance needs to have people challenging the orthodoxy and challenging the old-boy networks. That does not mean to say that they are in there acting for the public interest. The public interest can do one of three things: legislate, tax or force insurance. Those are the three elements that we can insist on in terms of trying to protect the public interest in these banking decisions. You can make them insure for anything that happens; you can legislate to ensure it does not happen or you can tax to ensure that there is a premium paid.

Remuneration committees have a role to play in this, and perhaps we will ensure that remuneration committees are more independent than the boards. I do not know about "NIFE", but you could have the National Agency for Finance - that would be "NAF"!

Paul Myners: I think corporate governance is very important here. I have talked at length about the ownerless corporation. There is a very serious vacuum where our major institutions are not directly owned by anybody. The ownership is distributed and we have come to believe that that
is the right model.

We were asked a very interesting question by somebody from an emerging country: "What model should we take for our private sector? Would you recommend that we copy what you do, with your major companies being owned by thousands of investors with nobody owning more than 1-2 per cent?"

We might have to put our hands on our hearts and say it has some weaknesses; there are some agency costs there. To some extent, bank profitability is over-reported because banks benefit from a guarantee for which they pay no premium, so returns on equity are overstated and that is one of the issues our recent paper addresses. I would like to see more shareholder engagement and we want to see better boards that are well informed and more challenging, and boards that are more diverse in membership, by which I do not mean just ethnicity and gender, I mean by way of background. This would mean that they are genuinely challenging. It is clear that the board of RBS, in particular, simply did not challenge the executive of that bank.

Alex Brummer: Peter Wilson has a question on morality.

Q. Peter Wilson, trainee journalist: I was just wondering if the panel agrees with Lloyd Blankfein, the chief executive of Goldman Sachs, who claimed that the bankers do God's work?

A. Mark Hoban: I think that people operating in any sector of life, whether it is banking, manufacturing, politics or the media, should have a strong set of values and ethics that they use to inform how they do their business.

Alex Brummer: Paul, I know you are considering a role in the church, or a strong moral role in the future.

Paul Myners: I want to study matters relating to faith and I think that values have to be at the heart of everything we do. I do not think that actually means that you are doing God's work. In truth, I think that Lloyd Blankfein did not mean what he said. I think he thought he was being ironic and it has backfired.

Colin Breed: I think he probably regrets this quote significantly but, having said that, unless there are some ethical values that underpin the whole of society, not just the banking industry, we would all be in a far worse state. To a certain extent, he may be doing God's work, but I believe that we all are as well.

Alex Brummer: Thank you all for your contributions. We have discussed three main issues that have attracted attention. I am amazed by the amount of agreement that there is about tax on bonuses. We do not see it as a bad thing and it will not ruin the City of London, so long as it stays as a one-off tax.

There is still much disagreement about the correct shape of regulation; whether this new Council for Financial Stability will be sufficient; whether we will have the unified, strong response to crisis that we have had in the past; and whether living wills are really the full answer to that.

The third issue that has been exposed here is that there is a lot of worry about the competitiveness of the banks: whether the banks can be competitive in the current marketplace; whether these new banks, if they do emerge, will have any chance of surviving, given the capital requirements that we will impose on them. I wonder if John Varley could briefly respond to some of those points.

John Varley: You give me an impossible task and I will not even try, but I will make a couple of points. One is that it is clear to me, as I travel the world, talking to governments, regulators and central banks, that an enormous effort is being mobilised to ensure that the events of the past three years cannot recur.

I have to say that I feel a sense of optimism about the efficacy of that effort. I would be very surprised if decisions are not made that have rigour and prevent that recurrence. They must, and banks have their role to play in that. This is a globalising industry and it is essential to the competitiveness of the UK banks, and the contribution they make to our economy, that those decisions are consistent around the world. I do not mind what is thrown at the industry, providing that it is thrown at the whole industry. I worry a lot about there being inconsistent implementation of regulatory, or central bank, or legislative change.

The second point is that there has been a lot of focus on governance, and I understand that, but, to me, the heart of a safe solution going forward is in culture. We try to define culture as what our people do when their bosses are not with them. In other words: is it innate for them to behave properly? The creation and enforcement of good culture in banking organisations around the world - which is what systemic safety will depend on over the course of the next decades - is an obligation of the board, more than anything else. The board has to do that; regulators and legislators cannot create that culture, the boards have to create the culture.

This article is taken from the New Statesman supplement Held To Account: What's next for UK Banking? sponsored by Barclays