24
Examination of witnesses
Charlie Nunn and Robert Begbie.
Q141 The Chair: Welcome to today’s meeting, which is the 13th oral evidence session as part of the committee’s inquiry into the growth of private markets in the UK following reforms introduced after 2008. Thank you to Mr Begbie and Mr Nunn for attending.
This session is open to the public, is broadcast live and is subsequently accessible via the parliamentary website. A verbatim transcript will be taken of the evidence and will be put on the parliamentary website. A few days after this session, you will be sent a copy of the transcript to check it for accuracy, and it would be helpful if you could advise us of any corrections as quickly as possible. If after this evidence session you want to clarify or amplify any points made during your evidence, or have additional points to make, you are welcome to submit supplementary written evidence to us.
Would either of you like to make an opening statement explaining who you are and your involvement in this area of inquiry? Shall we start with you, Mr Nunn?
Charlie Nunn: Thank you, Lord Chair, for inviting me today to give evidence. This is a very important topic, and I welcome the committee’s thoughtful work on this critical issue for the UK economy.
By way of introduction, I am CEO of Lloyds Banking Group, which provides financial services to 28 million customers in the UK. The committee may be aware that, as well as banking brands, our group also has an insurance, pensions and investment business, including Scottish Widows. We also have a small private equity arm, Lloyds Development Capital, which may be relevant to some of the topics we will come to discuss this morning.
For this inquiry, it is worth stating at the outset that the terms “private markets” and “non-banks” capture a very broad ecosystem, and I know the committee has explored this point in previous evidence sessions. I tend to think of the ecosystem as mainly comprising private credit, private equity, venture capital, hedge funds, real money managers, insurers and pension providers, a very wide range of actors, some of which are regulated and others of which are not.
In my view, a healthy, competitive and vibrant UK economy requires both strong banks and non-banks. Banks are uniquely able to create trust in deposits while channelling deposits into the real economy as lending so that people can buy homes and businesses can grow. Banks differ fundamentally from non-banks on how their risk and liquidity is managed. This results in natural structural advantages for non-banks over banks in certain sectors. Similarly, there are important functions and types of lending that only banks can make to the real economy.
While regulatory reform was needed after the financial crisis, the combined impact of prudential and conduct regulation needs to be recalibrated to allow banks to better support customers of all sizes, whether retail, a small business or a large corporate. The Government and the regulators have made a start through the Mansion House and Leeds reforms, which we welcome and now need to see delivered ambitiously and at pace.
Attention must also be given to non-banks to enhance transparency around risks posed by that sector’s growth. For the economy to thrive safely, the interdependence between banks and non-bank institutions must be transparent and, once understood, managed in a way that maintains the UK’s position as an attractive destination for international capital while enhancing the competitiveness of the UK banking sector and its unique ability to support the UK’s long-term economic growth and prosperity.
I look forward to the committee’s questions on the role of banks in this debate, and to discussing how we can collectively ensure that both bank and non-bank sectors are set up for success and can provide the best finance needed to fuel sustained long-term economic growth.
The Chair: That answers a few of our questions. Mr Begbie.
Robert Begbie: Good morning, Lord Chair and members of the committee. Thank you for inviting me to give evidence.
I am the chief executive of commercial and institutional at NatWest Group. I lead the bank’s support for micro-SMEs all the way through to global corporates and financial institutions. As the UK’s largest commercial bank, we have around 1.5 million businesses and corporate customers, with more than £150 billion in lending in my business. I have been with NatWest for more than 40 years, holding senior leadership roles across group treasury and in our markets business. Overall, my experience has given me a broad perspective of the business, our customers and how we fit within the wider economy.
Today, I would like to emphasise three points. On SME lending, the market has evolved significantly since the financial crisis, with more participants across the bank and non-bank space. I spend a lot of time travelling around the country talking to customers, and it is clear to me that NatWest plays a crucial role in supporting businesses and driving economic growth, with substantial lending volumes, deep customer relationships and strong regional presence.
On the impact of capital and liquidity requirements, we are fully supportive of high-quality regulation. We are not advocating for a return to the past. The priority is to ensure that the framework is fit for purpose and enables us to continue to support the Government’s growth ambitions. We need a good balance between strong safeguards and growth.
On the role of private markets, including private credit, they have grown as a source of real economy financing since the financial crisis, but have existed for a number of decades. I believe it is only right that we work with financial sponsors and funds across key global markets to ensure this ecosystem supports UK growth. The key is to ensure sound risk management, which we place at the heart of our business strategy.
I hope that gives you a clear sense of NatWest’s commitment to supporting businesses, along with my background. I look forward to answering your questions.
Q142 The Chair: Thank you very much. Perhaps I could start with a question for both of you, starting with Mr Nunn. You talked about the need for recalibration. We have had evidence that, following the financial crisis, the banks have retreated from lending directly to certain markets. Do you both agree with that statement?
Charlie Nunn: Thank you very much for the question. I will give you the view around recalibration and then answer this question of retreat.
First, as Robert said, we definitely believe that the reforms that have been made since the financial crisis have created a more stable environment, and we would not advocate going back to anything like the situation we had in 2007 and pre-2007. It is important that those reforms stick and that the stability that we have achieved in financial services stays. That is the first starting point.
Secondly, yes, we do believe there is an opportunity now for a recalibration and a real focus on the real economy from the SMEs that Robert was talking about, which we both support and have thousands of RMs across the whole country supporting, all the way through to large corporates, infrastructure and government investment. We are in a position now where the cost of capital and the regulation is not fully supportive of the banks supporting those sectors fully. I can come back to that later if that is helpful, Lord Chair.
Specifically on whether the bank sector has retreated, I would not characterise it that way. When you look at the specifics between banks and non-banks since the financial crisis, the banks have had a significant increase in the amount of capital they have to hold to do the same type of lending that we did before the financial crisis. Of course, critically, the banks have access to liquidity for retail customers and small businesses, and the costs of managing that liquidity have materially changed. For most types of lending, that would be more than a doubling of the cost of capital and the cost of liquidity.
The banks have a regulatory requirement to make sure that the cost of capital and funding is included in our pricing, and we also include stress events in our pricing. In response, we have had to build higher costs of borrowing for customers and exclude certain types and terms of lending which is not seen to be aligned with the regulation. We have seen higher costs of borrowing in that environment, which has resulted in the banks participating to a smaller degree in the overall bank lending and financing of the UK economy since the financial crisis.
I have two other thoughts and then I will go anywhere you would like. Robert talked about this, and I mentioned it in my opening statement. There are some parts of the UK economy that only banks support. Banks—and some of the smaller banks—are still the major providers of finance to SMEs. It is an incredibly competitive market. Good small banks have emerged, but none of those subcategories of non-banks participates in it at any scale. Where they are starting to use—I will use the phrase—regulatory arbitrage to try to look at serving those customers, they do it through the big bank platforms or other providers. So, first of all and critically, SMEs are really being supported by banks.
Some other parts of financing the UK economy are the same, such as development finance for large infrastructure and working capital. All large corporates have to have a working line of credit called a revolving credit facility by law, and banks are typically the only providers of those in the economy. It is critical that we get the cost of credit for all those activities for the real economy right and that we have a vibrant banking sector going forward.
The Chair: For those people who do not understand liquidity, capital requirements, risk weightings and the huge complexity, is it fair to say that the SMEs are not being lent to because you cannot make much money lending to them and, therefore, you have looked to other sectors?
Charlie Nunn: No. Robert will have a view. We are keen to lend to the SME sector. We have over £30 billion lent and broader undrawn lines this year alone. We onboarded 100,000 SMEs. We are lending over £6 billion this year. As I said, we have over 1,000 colleagues right across the country.
The Chair: The capital requirements and liquidity requirements are not a problem, then?
Charlie Nunn: They mean that the cost of borrowing for the lenders is significantly higher than it was before the financial crisis. We have seen in the last 10 years that borrowers, lenders and SMEs in this context have been through a huge amount of uncertainty.
I think of it in three phases. We had the post-financial crisis period, when they were deleveraging, they had overextended themselves and the economy was very difficult. We then had the uncertainty and the increases in their costs that happened post-Covid. Of course, during Covid, many SMEs took a lot of additional borrowing through government-backed schemes. We are now in a period when SMEs are quite healthy relative to any period since the financial crisis, but their costs of doing business, their costs of borrowing and their uncertainty around the economy and geopolitics are very high. We see muted demand at this stage, although it is growing again in 2025 versus 2024.
Robert Begbie: To build on a couple of points that Charlie has made, we do not agree that we have retreated from supporting small businesses. If anything, our commitment to it has strengthened. Since the financial crisis, despite the restructuring of balance sheets, we have remained a key provider of funding to the SME market.
We mentioned Covid. During Covid, we were one of the largest providers of CBILS and BBLS loans, delivering nearly 250,000 loans totalling about £9 billion. That overhang has impacted the market as those repayments are coming through.
Post-Covid, we have invested heavily in providing access to finance. It includes building a digital lending journey for faster, easier funding, and expanding our broker team to support businesses using intermediary services. As a result, gross new lending this year is up 50% year on year to our business banking customers. While support has grown, business appetite for leverage and risk fundamentally shifted after 2008, and subsequent shocks—Brexit, the pandemic, inflation—reinforced that cautious approach. This has likely suppressed some borrowing demand from otherwise strong, viable businesses that may partly explain the UK’s ongoing productivity challenge.
Q143 Lord Sharkey: Good morning. Are you experiencing more competition from private credit funds and, if so, in which market segments are you experiencing more competition? Is there evidence that banks are competing on lending standards?
We have received evidence from the Loan Market Association to suggest that banks offering syndicated lending increasingly offer covenant-lite lending. The Wall Street Journal last week ran an article that talked about the increase in real-time covenant changes as a warning sign.
Are you seeing evidence of a loosening of covenants on debt and, if so, who is providing that?
Charlie Nunn: On the top-line question, are we seeing more competition from non-banks, the answer is yes. The committee has heard evidence over the last period of time that says, if you look at the total scale of funding to the UK economy, the whole growth in that funding since the financial crisis has come from non-banks. So at a macro level—I will talk about some of the specifics—the answer is yes to that.
The important point is where you were going with the question, which is: where do we see that funding? Again, our stance is very much, for a vibrant economy and for the needs that this economy has, to invest in everything we need and to build the productivity that Robert was talking about. Non-bank financing is critical.
We typically see more competition from places such as, for example, private credit and insurance companies looking to take long-term positions to support long-dated investments and long-dated assets. Again, when you look at the arbitrage they can take on regulation and their lower costs of capital and funding, and the fact that they often have very long-dated liabilities—insurance companies and pensions companies will have liabilities and deposits locked in for 30, 40 or 50 years, and private credit and equity often seven to 10-plus years—they are good structures for doing that financing. We have definitely seen maturity in that market, and that has come to bear.
Certainly for Lloyds Banking Group—and I am sure you will hear the same from Robert—the banks have become critical to structuring those kinds of deals and investments and working with those types of finance. Very often—although it is not always true because there are different types, even with private credit and private equity—those firms do not want to do development finance. With any significant development, whether it is building houses or building the new nuclear power station that has been announced, during the development phase, banks are often needed to provide that financing. In fact, insurance companies cannot take the asset into their insurance company, such as Scottish Widows, until it becomes an income earning asset and has got through the development phase. Yes, significant competition has driven a lot of the growth we have seen in the last few years.
Our view strategically—and I will come back to talk about covenants and standards—is that, when you look at that overall shift between non-banks and bank financing over the last 15 years and if you were to run that forward another 10 years, it would put the UK in a difficult place for the following three reasons.
First, UK banks are deeply committed to the UK. If the UK gets into stress or trouble, we will continue to finance the UK. A lot of those non-bank institutions are international funds managed through international firms regulated overseas, and they will decide, as they should, on behalf of their investors, where and how they allocate their investments as they go forward. Stability of funding under stress is critical.
Secondly, as we talked about, there are some really important parts of funding the UK and the real economy that non-banks do not do, whether it is SMEs, working capital, revolving credit facilities or development finance. You cannot deploy the long-term capital without those other things, and so we have to get the banking system and the regulation of it in the right place to enable it to be more vibrant and more competitive going forward.
Thirdly—this is not really the committee’s focus today—banks do some other critical functions. We facilitate payments and cash management. We do all the risk management around inflation rates and FX. Ignore retail banking for a second. On the commercial side, if you talk to a treasurer or a CEO, often those other functions differentiate and enable them to operate. Very often, the lending in banks does not cover our cost of equity, and we facilitate having a profitable bank and relationship with our customers through those ancillary services. We have to maintain that resilience and that competitiveness of banking.
You asked whether we are seeing practices or covenants changing. They do have different approaches to covenants and practices, because they have different inherent risks through the way in which capital and liquidity happen. We have not seen any material deterioration, if you like, in that context.
We are not exposed to what has happened in the US, but we have a £900 billion balance sheet deployed largely against the UK. In my role, you have to take those events seriously and learn from them. At least one of the events in the US feels and looks like a fraud, which is quite material. We have to be humble and always recognise that we can learn from that in terms of the scope of our business.
The other one, though, looks like a set of poorer credit decisions, sometimes facilitated by smaller private credit companies and sometimes supported by activity from some of the rating agencies. It is not clear to me at this stage whether that is systemic, but we do not see that at this stage in the UK, certainly from Lloyds Banking Group’s perspective.
Robert Begbie: To build on a couple of points, we touched on this earlier. We see a wide range of different competitors in the marketplace, some of which were not around 10 or 12 years ago, but that includes foreign banks, neobanks, challengers, fintechs and private credit.
The point I would build on is that they tend to be monoline product or experience providers. They do not provide that broad range of products and services that a relationship bank can, and we build our relationships and ultimately our returns on customers from having that. That is all the way through from small businesses right up to dealing with private credit firms. We offer a broad range of services from helping them set up their fund in Luxembourg or Jersey through the cash management foreign exchange and, yes, there could be some lending against that, but the overall relationship is broad and a banking relationship with that.
On the point of covenants, we are clear. We are not compromising our underwriting standards or our covenants, and we will walk away from transactions if we think that they do not meet our risk appetite framework.
Q144 Lord Hollick: Could we go to the other end of the spectrum and look at large funding? We heard last week from Apollo about its £4.5 billion funding for Hinkley Point. That is part of an important and large-scale programme of investment in UK infrastructure that the Government are promoting. What role do you play in that? Let us start with Robert.
Robert Begbie: Yes, we are a significant player in the UK infrastructure market. We will provide everything from debt financing through to risk management services and banking services for those projects. Yes, we would look to be fully involved as a bank.
Lord Hollick: Did you compete for that project?
Robert Begbie: I can come back to you on that. We were involved in discussions.
Lord Hollick: The sheer size of it and the fact that it is seven years may be a deterrent.
Charlie Nunn: I will come back to it. This is not a competitive statement. We were the biggest infrastructure and project finance bank last year and so we are deeply committed. We have done £100 billion of infrastructure financing in the last five years in the UK, with £20 billion in social housing, so these numbers do not scare us. That is a very big single-ticket line, as you said. We did help and were involved in that discussion.
Earlier I mentioned examples where the private credit industry or, more broadly, the non-banks can be an important source of financing and capital for some of the things the UK wants to do. For me, that is a good example, partly because they have a lower cost, as we know, around liquidity and credit—as I have said a couple of times—and they can pass that on.
To give you a feel for this, and I will not talk about specific firms, if that is okay, if a private credit firm is doing this in the context of an insurance entity—and it is public knowledge that Apollo owns an insurance company in the Midwest called Athene—it will often look for a return on equity for those loans that is less than half of what we are obliged to hold from a regulatory perspective. Our stance is that that is great. They have tied liquidity. They are the better patient capital providers.
By the way, some of our big insurance companies in the UK—and Phoenix is a good example that you mentioned earlier—are also under the Solvency II reforms, which I know this committee will have talked about, in a position to deploy long-term patient capital at materially lower costs. We often help structure those facilities, phase support of the development financing for those facilities, and manage the risk from an interest and a rates facility around those facilities. Yesterday, another major nuclear power financing commitment was put out, which was a combination of banks doing the financing. Lloyds alone, along with about five or 10 other banks, put £663 million into that nuclear power station financing.
So, yes, we absolutely participate. It is a good example of the kind of area where you need a vibrant non-banking sector because it plays a fundamentally different role. Importantly for us, and for me in this context, the banks very often make that happen, and the banks today are not as competitive as they need to be. We believe there is an opportunity to look at some of the capital and regulatory reforms in that context.
Lord Hollick: When we look at the interconnectedness between your banks and the private finance market, interestingly, you said that in your group, Mr Nunn, you have an insurance company and a private equity company. Within the same family, you have to review that interconnectedness.
It appears from what you have said that the capital arbitrage advantages private finance in quite a lot of areas but, by the same token, you now lend to those private finance companies, which is a little bit ironic. How do you manage that? How do you assess the risks of lending that you are not taking on your own balance sheet? I am not talking about the ones that are in your own group. Is there sufficient information and visibility on the real risks that are being undertaken by private finance so that you are able to risk-adjust the lending that you do to that sector? Robert?
Robert Begbie: We do, as we have said, deal with private credit. It is part of that overall ecosystem. As I have touched on, we provide full banking services to them. It is not just a lending-only type of business.
We selectively provide lending into private credit. We do it with large firms. We do not struggle with opacity in the information we need from the sponsor customers. We perform extensive credit diligence before entering a transaction and detailed ongoing credit monitoring. Typically, we find the work that certainly the larger sponsors have undertaken to be extensive and high quality.
Again, back to my point a little bit on covenants, we will not enter into transactions unless we are completely comfortable from a risk appetite perspective and an underwriting perspective that they meet our criteria.
Charlie Nunn: Taking a step back, the committee’s focus on the point of interconnectivity is welcomed and it is an area for action.
Lloyds Banking Group has a clear business model. We have connectivity at a few levels. First, we do some private equity fund finance, not private credit, and we do not do some of the practices that we know have exposure to more risk for the banking industry such as asset-backed lending around collections of loans.[1] We do private equity finance for known funds at the fund level. That is a very long-term established business. In fact, we have not had a single capital loss in 35 years. The great thing about that business is that it is getting money from investors into scaling up businesses. It is a private equity business, not private credit.
The second big area where we have an interplay is that we are the biggest originator of lending in the UK, full stop. We have lots of counterparties, asset managers, hedge funds and private credit firms that will be better natural owners of that risk. We have a securitisation market. I know the committee has also looked at significant risk transfers on CRE portfolios. We will often package, structure and then syndicate or share that risk into the non-bank financing sector.
The third point at which we have a relationship is, as I was talking about earlier, the critical role around managing risk, whether it is inflation risk, interest rate risk or currency risk. We have one of the leading sterling and then euro businesses—and Robert does as well—to help provide short and long-dated protection against those risks. That results in collateral being shared with the non-bank sector, and long-term exposure.
I will say two critical things on this. We welcome the review by the various committees that have looked at this, both domestically with the FPC and then the FSB, with the governor chairing that, to look at transparency in more detail.
Secondly, yes, we absolutely have the data we need to manage our risks, but we believe we need to be careful to not make the banks accountable for the risks of the non-bank sector or providing that transparency. Otherwise, it will make us less competitive. We believe that the transparency is needed. It would be absolutely right for the regulators to determine how to manage that risk directly through the sector, not through the banking sector. I would be concerned for the future of the UK if it were to go down that path, especially in the international competitiveness environment we are currently in.
Lord Hollick: How do you inoculate yourself from the risks that may emerge only after you make the lending? That is what, essentially, the Governor of the Bank of England is saying. The alarm bells are ringing.
Charlie Nunn: Again, the confidence I want to give you is that Lloyds Banking Group has a clear strategy and a clear set of risks. Unfortunately, for this committee, I will not be able to talk to you about some of the parts of the interplay between different parts of the industry, bank and non-bank, which are harder for that prime brokerage and hedge funds, some of the credit fund structures and lending.
For Lloyds Banking Group, the risk is all clearly defined. I can give you an example. We have a clear line of sight to the ultimate payers for that risk and then we are able to manage collateral. Our private equity business is all relatively simple lines with relatively short duration at the fund level. We have a call to the ultimate investors in those private equity funds. Often, they are sovereign wealth funds, other pension funds and insurance funds. We do not provide significant leverage, and we do not do significant NAV lending against the underlying assets in the portfolio, which have the real risk. We have a clearly defined business model and we are very resilient, as Robert was saying, around understanding our risk and exposure.
Other firms—and this is not a negative because the world needs this—take a different view on that interdependency. Again, that is why we believe the transparency around the risks in the non-bank sector and then how regulators, both domestic and internationally, should look to make sure they emerge appropriately is an important next step.
Q145 Lord Eatwell: What is your risk weight on lending to private capital?
Robert Begbie: Single-name, unrated corporate lending will attract a higher risk weighting than typically what you would get in the private markets, given that the private markets are looking at a portfolio of different risks that are packaged together, some of that risk being onsold. Therefore, what you end up holding attracts a lower risk weighting than typically lending against an unrated corporate. That is the RW treatment that is set in the regulation for how we assess those risk weights on our balance sheet.
Charlie Nunn: To build on that—and I know it is an unhelpful answer, so apologies—it depends. Some large corporates are good credit quality and have lower risk weights than some of the financing we will do for some types of funds.
Within funds, I talked about high-quality, short-term lending to private equity where you have a call on the ultimate investors. That, almost by definition, is low-risk-weighted lending. As I said, we have not had a single loss in 35 years, running all the way through the financial crisis, and we are one of the biggest providers of this type of lending to private sponsors in the UK.
Lord Eatwell: Mr Begbie said—and correct me if I did not hear you properly—that the risk weight that you apply to lending to a private sector lender is lower than if you were doing it directly yourself.
Robert Begbie: On average. That depends, as Charlie said, on the structure of the fund itself and the nature of the corporate. Typically, the models would give you those differential risk weightings.
The Chair: Presumably, that is the sort of business you would go after, where there was a differential risk weighting that was to your advantage.
Robert Begbie: Lloyds is a broad-based bank. The core of our business is in the UK and our retail, SME, mid-corporate, large corporate businesses. That is the bank we are. As I have outlined, we selectively participate in those markets because of the ecosystem that originates from. We also use SRTs as part of effectively managing our capital.
Q146 Baroness Bowles of Berkhamsted: We have already wandered over all the questions that I wanted to explore, but maybe we can make it a little bit simpler. There are interconnections with the private credit markets, coinvesting, fund finance and the things that you have been discussing.
Can you say a little bit more about the life cycle of what happens in those interconnections and what has changed from back in the times of the financial crisis? I do not mean regulatory changes. We take it as given that a bit more monitoring is going on. What else has changed to make sure that things do not come back to bite you or to make sure that you are not holding bits of risk in securitisations that you do not know you hold and that kind of thing?
Charlie Nunn: Would you like me to have a go at that one? Look, a lot has changed in terms of our participation. Also, as Robert was saying, a lot has developed in the non-bank sector, both in the regulation of it, which has allowed it to do new things, and in the innovation—it is a vague form of innovation. The one that the committee has probably talked a lot about is in the private credit space, with private credit companies starting to manage insurance businesses with very long-dated lower cost of liquidity. A lot is changing on both sides.
With respect to banks’ participation, I would love to share with the committee our thoughts about this at some stage. We hold significantly higher levels of capital, more than double. My point on this is that we hold about 2% more capital at the overall level than other G7 economies and equivalent banks that operate at this level.
We have detailed models to hold additional risk-weighted assets, as the committee has been talking about, for each type of activity around lending. Just before the credit crisis, we started to have to hold money for lines of credit even if they are not drawn and to manage liquidity for lines of credit even if they are not drawn. At this stage, the corporate sector and SME sector in the UK is drawing only about 60% of our undrawn lines. That has a material impact.
For any asset we hold, even when we are securitising it and moving it off our balance sheet, we have to hold both the capital and the cost of funding under stress. The regulations require us to try to price stress into our lending, which again has changed significantly. This is not just regulation, but it has been a big driver of what has changed. All those things mean that, as a bank, we have much more transparency and clarity around the risks.
We have to hold capital and funding for a stressed scenario and a fully drawn scenario. Then we do that in most of our portfolios intra-day. I always talk about taking very long-dated assets and linking them back to day-to-day mark to market, and taking very long-term liquidity and pricing it daily. Our teams and our businesses largely do that. A lot of that was not being done before the financial crisis.
If you take a step back, that means that we do have clarity around our risks and exposures. Therefore, we have a higher cost of providing credit or the interdependencies to the non-banking sector. That is why you have seen what was characterised as a retreat. We have seen that it is more financially beneficial to our customers to have tapped into the non-banks since the financial crisis. That has been going on through this period.
The two biggest areas of innovation that we see in non-banks would be how insurance companies are moving towards defined contribution schemes and then using these very long-dated annuity defined benefit schemes to start to build very long-term assets. You will have heard from some other players doing that, and we do that at Scottish Widows. The private credit industry is also trying to move into the insurance space, which gives it much longer-term liquidity and a much lower cost of lending in that context. These are significant changes.
Baroness Bowles of Berkhamsted: The bank changes are mainly the transparency in the risk and making sure that, hopefully, bad things do not happen. Some business has moved out because it is cheaper in the private sector, but is more going on overall? A much larger volume is going on in the private sector than there used to be. That has not all come from banks. That is all new, is it?
Charlie Nunn: Would you like me to have a go at that?
Baroness Bowles of Berkhamsted: Either of you can answer it.
Robert Begbie: We have talked about the growth of the non-bank financial institution space, which has grown significantly since the financial crisis for a number of reasons. Some of that we have talked about. They are more natural holders of certain assets, and they get an advantage through not having the regulation. That is happening. It is important for us to play a part in that because it is now part of the ecosystem that drives investment into the UK.
We are a bank, and trust and transparency are at the heart of what we do. The regulation that Charlie touched on—and I was group treasurer as a number of iterations of that came through—has meant that we do a lot of stress testing on all aspects of our balance sheet, both regulatory submissions and also our own internal stress testing to make sure that we are comfortable with the risks that we are holding.
I echo the point that we would welcome a stress test specifically around the area of private markets that has been talked about. Equally, I would also make the point that it cannot just be around the banks. It has to be around what the overall ecosystem looks like.
The growth in this market goes back decades, and it is continuing to grow. We will all need to be mindful of the impact of that on the UK economy and banks.
Q147 Lord Lilley: This question may be more for your bank economists rather than for bank chief executives, but I am interested in trying to understand whether the growth in private non-bank lending has come at the expense of other forms of lending or is a net increase in lending. To an economist, any increase in net investment requires an increase in net saving. As far as I know, there has been no increase in net saving in the economy. Therefore, an increase in one form of investment must have come at the expense of another form of investment.
Has the growth of private non-bank lending come at the expense of banks or at the expense of something else?
Charlie Nunn: Do you want me to have a go at that? It is a great question. Let me try to answer it and, please, tell me if I am not being helpful because it is a fundamental question.
As an aside, one interesting thing in the last 15 years is that the savings rate has increased, especially post-Covid, and it has stayed high. It has doubled. I will be conflicted, if you do not mind, and biased towards banking. If you want to put money into the real economy, I love where you went. Savings equals investments if we were Keynesians. I was educated in Keynesianism at university. The best mechanism for putting money into SMEs’ and entrepreneurs’ hands is by saving in your bank because we are the only people who try to deploy that into the real economy.
We have seen an increase in savings, and one big, unknown, fundamental question that I debate a lot with our economists is how sustainable that is, why that is happening and at what stage it will come back. Debt and deleveraging of both households and businesses, SMEs to large corporates, is now at the lowest level it has been since the financial crisis. We have seen both things happening, and those are business and consumer behaviours before I talk about the financing market. That means that in both those parts of our economy—independent from the Government, who we know have some challenges from a financial health perspective—there are households, individuals and businesses struggling to make ends meet but, broadly, when you look at the data, they are healthier today and they are saving more today than at any stage. There is a lack of confidence to spend among consumers, and a lack of confidence to invest for productivity and growth. That is the first starting point.
On your question around whether non-bank has crowded out bank financing, again, I know the committee has seen the data that was shared by the governor or another person who attended the committee who said the growth in financing has been about £454 billion and almost all of that has come from the non-bank sector. That is a direct consequence of the restructuring and repositioning we have had between the two sectors since the financial crisis, which we have talked a lot about.
Could there have been more investment during this period if the banks had been able to lend more? It is hard to have that counterfactual because we do not know. But based on the amount of capital the banks had to build, the restructuring and derisking they were forced to do, and then the cost of the lending they could do and therefore the lack of demand that came on the other side, we would all say we tried to play our part. Even today, I can give you quotes around significantly growing our lending to the economy, but whether we could have done more is an important question.
That is why one core point that we think is important for the committee to hear is that, now we have the financial resilience of the banking sector, this is the opportunity to ask whether both capital regulation and then conduct regulation are at the right level to allow us to play our important role in getting this economy growing again and in getting productivity growing. We believe there is an opportunity, both domestically relative to our real customers and internationally, for us to relook at that. I shared a couple of views, and I do not know whether it would be helpful for the committee.
The Chair: It would be helpful if you could be specific about what you see needs to be done.
Charlie Nunn: We think three things would be most helpful. First—and I will talk about only globally significant and domestically significant banks because we have a higher capital expectation, as we would want as a committee and as an industry—when you look at the overall capital stack that we hold in this country, we operate at about 12% across the big banks in the UK. If you look at similarly systemically important banks in the G7, the average regulatory capital is 10%. That is made up of a series of regulatory minimums that get you to the Basel standard of 7% and then buffers that are defined on top of that, called pillar 2 buffers in the UK. That means, at the aggregate level, we have to hold 2% more capital than other international banks—including international banks branching into the UK, by the way, which is interesting—and that cost has to be ultimately passed on to our customers. That is the first level.
Secondly, as always, regulation is quite complex, but we have within the capital stack specific models for specific parts of how we serve our customers. I guess the committee has heard this one as well, but one change being proposed at the moment as we move towards implementing Basel 3.1 on 1 January 2027 is a removal of the SME scalar, which will make it more expensive for SMEs to borrow. The PRA has listened to us and is trying to do some offsets, but it still means an increase of thousands of pounds for the average SME on the life of its loan. We think you could safely do more in that context.
Thirdly—it is more specific to SMEs and is not related to large corporates and institutional investing supporting infrastructure—conduct regulation under the consumer duty applies to SMEs. We believe that the Mansion House reforms and the Leeds reforms that this Government and some of the changes that the last Government were trying to put forward to try to make conduct regulation more predictable and more forward-looking are fundamental because the UK will have, overall, an investability problem if we do not have that. Our ability to invest and innovate in how we support SMEs will be compromised if we do not have that conduct certainty around SMEs. Those would be three specific things.
Lord Lilley: That is extremely helpful. You have answered not only my question but the next question I was going to ask, which means that I can move on to the final one, about us having higher reserve requirements than other banks. We heard from the former Governor of the Bank of England, Mervyn King—and I hope I am not misrecalling what he said—that he would prefer a system where you have significant reserve requirements but not detailed analysis or detailed regulation of how the lending is distributed to different forms of risk, if I am correctly interpreting him.
The Chair: I think he said that he would prefer to move away from risk weights towards leverage.
Lord Lilley: Exactly, yes; that is the right jargon and clearer. Do you agree with him?
Robert Begbie: At face value, the proposal has much to commend it in its simplicity. However, it is a significant shift away from the Basel framework that has been implemented over many years, and the standards that underpin not only UK but global prudential regulation. It would have to be explored in much more detail in the context of the level of international standards implementation to avoid fragmentation of regulation, given the criticality of global alignment for financial stability. It would have significant governance and operational challenges and could have unintended consequences if the UK were to move unilaterally. You also have the situation where investors, rating agencies and counterparties expect robust risk management assessment and disclosure.
Our preference would be continuing simplification and standardisation of the current regime, complemented by existing leverage ratios that are in place to prevent excess balance sheet growth. You would then get a balance between simplicity, risk sensitivity and international consistency.
Lord Lilley: Going back to your first point, there has been an increase in saving. That must mean there has been an increase in investment. Why do we not hear the Government trumpeting that?
Charlie Nunn: I cannot speak for the Government, but I have become a slight counternarrative voice on the underlying health of the economy, recognising that households, individuals and businesses are definitely struggling. If this economy had the right framework and confidence to invest, there is the capacity to move to a higher growth trajectory.
Having said that, businesses and households are not doing anything that we would not do ourselves. When you look at the world—the costs of activity, hiring people, international supply chains, and borrowing with interest rates above 4% and higher than they have been for 15 years—there is significant uncertainty in the economy. The cost of living crisis is real, especially for households in the bottom 20% of the economy, which we as the biggest retail bank by far in the UK see significantly. There is, as we know, significant geopolitical uncertainty.
The good news from our perspective is that both households and businesses have enough strength to consume more and to invest, but that broader uncertainty is holding businesses and households back. We are alive to that because we have spent so much of our time with those customers.
Q148 Lord Grabiner: I want to ask you about motor finance. I know that that is not at the core of today’s meeting but, since we have you here, I hope you do not mind me taking advantage of that fact. I know also that Lloyds has a significant commitment in this market. I do not know about NatWest, but perhaps you could tell us about that in a moment.
We have been talking to the FCA. The FCA has produced a consultation paper, and the time for responding to the inquiry was due to expire on 18 November. It has now been extended to 12 December. What is your view about the 18-year lookback, which is proposed in the consultation paper that has been produced, so that claims would go all the way back to 2007?
Charlie Nunn: Thank you, Lord Grabiner. I think this one is for me. Robert will probably explain in a second that NatWest does not support this industry. We are the biggest financer of new and second-hand cars in the UK and have been for a long period of time.
If it is okay, I will answer your specific question, but I feel obliged whenever I talk about this—
Lord Grabiner: Please do. I was going to ask you to develop it in any event. Like Lord Lilley, you answer the questions before they are asked, which is good.
The Chair: Most politicians do the opposite.
Charlie Nunn: That is why I would not be a good politician, Lord Chair. I have been appreciative of the line of questioning you have been going down. The car sector is an important sector. Across the UK, 80% of people need finance for new vehicles. Remember, 80% of people have less than £5,000 of savings. If you are going to buy a car of £15,000, £20,000 or £25,000, you cannot do it without finance. And 50% of second-hand cars need finance. This sector is fundamental, and the automotive sector is critical. We are focused on the sector and the stability of the sector as we go through this review.
Secondly, it is important to say that we welcome the FCA trying to intervene to give clarity and stability, first clarity for customers and then clarity for the industry, both the financing industry and the car manufacturers, which you will have probably also had a chance to talk to or hear from and which are quite surprised by how this is developing. It is important that the FCA is trying to step in to give that stability. We welcome both the FCA stepping in and the consultation it has made.
The third thing in that context is that we do not think that the scheme as it is proposed today is proportionate and is setting the right standard for remediation programmes as they go forward. As you say, we are deeply committed to consultation and we are working with the FCA on the consultation, so I probably will not talk in detail about some of the sharing and ideas we are doing.
As we look across, Lloyds Banking Group today finances about 16% or a sixth of all car financing in the UK. For what it is worth, we are the biggest owner of vehicles and electric vehicles as well. When we look at the impact of the scheme as it is currently proposed, it would result in a significant number of customers getting a windfall outcome that is not linked to harm and would not be fully proportionate.
Lord Grabiner: Is that because of the lookback period?
Charlie Nunn: I will come to the lookback period. Apologies, Lord Grabiner. On the lookback period, as you understand better than anyone, this is a complex environment. It is being assessed as unlawful relative to the Consumer Credit Act, not relative to the regulation. If something is unlawful, the time period is typically longer. The FCA is intending to provide closure and clarity for customers and feels that it will do that, especially given the professional representatives that have emerged in the UK and operate in a distinct way and more aggressively than in any other jurisdiction in the world. I say that having run businesses in 50 countries. We understand why the FCA is looking at that.
The key for us, depending on how the scheme is designed, is whether it results in a scheme that is linked to harm that can be implemented all the way back to 2007. That will be the key determinant for us as to whether we should go back to 2007. Where it is deemed that based on the law we have broken the rules—and you have seen that Lloyds Banking Group has provisioned £1.95 billion—we are ready to do the right thing for customers, but we are concerned that it needs to be proportionate and implementable so that customers have clarity and executionability. We are not comfortable with that at the moment.
Can I say one more thing in this context? Look, why is this important? Clearly, first, as I mentioned earlier, if the UK is going to remain an investable destination with clarity around the conduct regime, where businesses can invest and we can innovate, which has been massively suppressed in the UK relative to other economies in the last 15 years, and try to improve how we serve customers in the financial sector and other sectors, having a scheme like this that would take away more than 20 years of the profitability of this sector is a really difficult issue for both global companies looking to invest in the UK and, for that matter, for my investors looking to invest in financial services.
There is a deeply important investability issue for the UK coming out of this, looking back 20 years, with potentially a non-proportionate scheme that results in taking away 20 years of profitability of the car finance industry, which is really important but quite small. Therefore, we welcome this committee’s look at this.
Secondly, I am really worried about the strong functioning of this market going forward. We are committed to this market, and we will continue to finance it. Interestingly, we do not play a big part in those that have less money and are at the lower ends of the financing market. We are concerned that the implications of this scheme, whether it is car manufacturers or other independent financing companies, might impact either the cost or the availability of credit to some parts of the market. We are worried about it in those two contexts.
Lord Grabiner: Part of the problem, I suppose, is that if the scheme is enacted, so to speak, you will not fight these cases in a courtroom. You will end up having to pay up to anybody who brings a claim within that long lookback period.
Charlie Nunn: Yes. I have a couple of things to say, and I know, Lord Grabiner, that you have more experience than me in this context.
First, a large number of these cases came through the lower courts and, as you know, the claimant law firms or the professional representatives try to build cases, get precedence from the FOS from other cases, and then try to build their cases.
Lord Grabiner: We call them ambulance chasers here, yes.
Charlie Nunn: I would not do that, but I understand. By the way, they are largely funded by international private equity litigation funds, often based in Bermuda and other such locations. It is an important part of this ecosystem that is being created in the UK in a way that has not been supported in most other jurisdictions in the world. Look, we are concerned about how that is developing.
Lord Grabiner: You mentioned a few moments ago something about your investors. Who are your investors? I do not want to know their names, but who are they? What about the impact on your shareholders of this whole story?
Charlie Nunn: When I say my investors, it means everything. The good news is that we are the biggest retail-owned company in the UK. We have a very large number of UK retail investors through their pensions and then directly through their holdings of Lloyds Banking Group. As you would expect, the two large passive investment firms, BlackRock and Vanguard, which are typically managing money on behalf of pensioners all around the world, are our second biggest investors. Our active investors, some of which hold up to 5%, tend to be international money, either in the US or in Europe. I spend a lot of time with investors broadly and then specifically with the active investors.
As you say, the concern on this is not the specifics of this issue and the costs for Lloyds Banking Group. I mentioned that we have done a material provision. Interestingly, on the day I did my last provision, my share price went up because it gave some certainty and clarity. If I can use the phrase as a financier, the discount that you see on UK financial services is because of the broader question and, as I now spend quite a lot of time with other sectors, especially the car manufacturing sector, a concern that the UK is not investable with this outcome more broadly. We are concerned about that.
Lord Grabiner: I hope you continue to engage with the FCA on this. It is very important.
Charlie Nunn: We are deeply committed to doing that and to sharing the information that we can bring to help understand how we can get a scheme that is more proportionate and, critically, that can provide closure to those that we did not meet the rules for and that can keep the industry functioning.
Lord Grabiner: Mr Begbie, is NatWest engaged in this market?
Robert Begbie: No.
Lord Grabiner: Whether you are or not, do you have a view about this?
Robert Begbie: We are not in the scope of the FCA’s review. We will keep a watching brief on the consultation. I agree with Mr Nunn that it is important that the UK is an attractive place to come and invest and do business with. That would be my point, but it is not a material issue for NatWest.
Q149 The Chair: The experience of this committee is that people who are regulated by the regulators are reluctant to criticise the regulators, in public if not in private, but I will have a go. Do you not feel a bit aggrieved that there were several investigations by the regulators in this market over the years? Notwithstanding the point you make about the Consumer Credit Act, or indeed the limited nature of the judgment by the Supreme Court, does it not cause you concern that you were operating in line with the rulebook by the regulator and now find yourself having to make these huge provisions?
Charlie Nunn: Yes, it does, especially in the way I just described, from an overall investability sentiment around the UK, broadly based and then with respect to financial services. I am not trying to mince words or avoid the provocative way you asked the question.
The Chair: We are used to people trying not to answer that question.
Charlie Nunn: I am not going to avoid it, but I know that you have had the CEO of the FCA, Nikhil, with you here. It has made it very clear that its interpretation of this is that it is an unlawful legal breach. I know that the committee has gone deeply into this. That is based on a very detailed and, I thought, very thorough Supreme Court assessment of a single case, which was deemed egregious. It is also based on the important review that the High Court did of a single case, which was done under a judicial review, of which many people around this table will have a better understanding than me, which does not really allow you to tackle the point of law.
In this case, it is more about: did the FOS follow a process that was deemed reasonable and could it have come to that right conclusion? Critically, the FCA has linked this to an unlawful unfairness case. That explains why it thinks then about the duration and what it means relative to its role. I will not speak for the CEO of the FCA, because it is for him to answer those questions, but that is what we understand. We will definitely engage on that basis, because there are some points of law that we need to make sure we have a clear understanding of. Most importantly, we definitely believe that the scheme needs to be proportionate, linked to harm and implementable so that it can provide clarity to customers.
The Chair: Is that not the key point: who has actually suffered harm? When they want to buy a motor car, most consumers want to know how much it will cost per month and they make a choice on that basis. They are not considering the underlying interest rate or any of these issues. On my understanding of what the FCA is proposing, people who took out credit and then paid it off to get a better discount from the retailer, for example, would be in the scope of being considered to have suffered harm and therefore be open for compensation. This is a nonsense, is it not?
Charlie Nunn: This is one I might offer to come back on. We are sharing all the points where we do not think the scheme is proportionate or linked to harm. I do not want to do anything to compromise the current consultation. I would very happily share the data back if that were okay.
The Chair: I realise that I am being very unfair.
Charlie Nunn: I do think that it is the core point, Lord Chair.
Q150 Lord Grabiner: I have one other point that might be helpful for you to be looking at. According to the paperwork that has been published by the FCA, and it is voluminous, 60% of the policy documents that it has looked at warn or tell the consumer—the potential buyer or person being financed—that there is or may be a commission arrangement in place. That ought to have put a fair-minded reader on notice of the commission issue.
If that is right—and I take your point about the need for investigating the particular facts of individual cases, which you obviously cannot do when you are looking at the big picture—there would be no justification for breaking the six-year limitation period if people had failed. They had been put on notice but had failed to do anything about it.
The result of the published exercise by the FCA is that, even if people were put on notice, nevertheless it would be appropriate—using your expression about unlawfulness—to assume that all the people who are making claims will be entitled to an 18-year lookback, even though if the individual case were in court, they would not achieve it and they would not be allowed to go back beyond six years and a bit, whatever it may be.
Charlie Nunn: I completely agree, and you describe some of the challenges in detail that we see with the scheme as it is currently laid out. As I say, we are definitely bringing a very detailed review over the full life of the data, because we have invested heavily to get the data in a place that can highlight how the scheme would operate on those issues and the issues that it creates in that context. Yes, I am at a level of detail here where I can go very deep.
I have one other thought connecting your questions, which I know the committee will understand, but it is important to say. Because of the specific breach of the law and under the Consumer Credit Act, this is a technical breach of the lender’s responsibility through the dealer. To your point, I spend a lot of time with customers, dealers and car manufacturers, and the key data point that is excluded from the legal interpretation but that the customer experiences is that typically people were getting value from the discount on the car they were buying, often a trade-in value that was higher or lower, and then sometimes value-added services such as a paint job and all that stuff, and the cost of credit.
When you talk to dealers all the way through this period, they had a number in mind that they were trying to optimise for. For some people, paying more up front was better than paying less later. They were typically optimising, even during this period of discretionary commissions, which the Supreme Court did not look at but which is the majority of the FCA scheme. Discretionary commissions before 2021 are not something the Supreme Court looked at. In the majority of those cases, it was a trade-off between the value of the car and the cost of credit.
Of course, because it is a point of law that does not look at the broader value exchange, and because the FCA has designed a scheme just on the cost of credit, that has been ignored in whether the customer actually got a good deal. I am not saying that I disagree with the point of law. I completely accept and respect the point of law. But when you take the human response around the kitchen table as to what really happened here, we believe it is a more complex issue. The scheme is not designed to do that; it is designed to respond to the point of law that has changed. That is why we will engage fully on that scheme.
Lord Lilley: You said that the cost of the scheme will wipe out 20 years of profitability of the sector, yet the scheme is supposed to remedy that element of the profit, which is only part of it, which was illegal or improper. If it wipes out the whole profit, it is not remedial; it is punitive.
Charlie Nunn: I agree, and that is why I thought it was a helpful data point to share with the committee. We need to make sure that we are helping the country progress, alongside this specific issue.
As you know, the Mansion House reforms and the Leeds reforms have looked at the FOS and they have proposed a 10-year backstop. The FCA in this context has proposed a different interest rate on remediation, which is the base rate plus 1%. That is important, and we welcome those changes. A whole set of other changes were proposed between how the FCA and the FOS work around read-across.
There is a regulation called DISP that I am personally obliged to meet, which the FCA can put into place without primary legislation. That broader package of changes that was announced both by the CEO of the FCA and, critically, in the Mansion House and Leeds reforms, and then the legislation that will be required to push that into Parliament, are really important for the reasons that we have talked about, to get this whole situation and our industry focused on a more forward-looking and, critically, predictable conduct regulation.
Wherever the bar is set, we will meet the standard. I have managed banks in 55 countries. In the UK, the bar is the highest of any country in which I have operated. It does not matter; we are already the best at meeting those standards and we will meet the standard of the bar. The difficulty is if the standard changes. If it changes retrospectively, it becomes difficult for banks, for car manufacturers and for investors internationally to operate in this environment.
Q151 Lord Kestenbaum: My question is not about motor insurance. Could you say more about supply of and demand for capital? It is something that we have talked around. You will have seen the evidence that this committee has received. You will have read that the public protocol is mixed on this. Some who have given us evidence, notably SME representatives, have said that there is pent-up demand that is unmet because, in large measure, traditional lenders are just constrained from doing more. You have touched on that. Others—we have heard them very recently—have said that it is simply about commercial investable propositions and wherever there is a commercial investable proposition, that demand is met. When things are not met, it is because it is not investable.
I return to your point, Mr Nunn, about recalibration. Your quote was that banks are “not as competitive” as they might be. It was a very strong phrase. How would you react to this proposition about supply of and demand for capital? You gave examples of recalibration, SME scalers, contact regulation and capital stack. If such areas, to use your word, are recalibrated, would the logic be that the cost of capital comes down, regulatory burden comes down and lenders such as you would thereby be able to do more? That pent-up demand currently unmet would be met, so there would be a tangible outcome from this recalibration when it comes to your ability to lend.
Charlie Nunn: I will answer first and then go to you, Robert. The simple answer for me is yes. It is a very competitive market. More than 50% of the market, not from lending to SMEs, is done by smaller banks. If we could reduce the cost of capital and the cost of funding and still manage the risk, we would see that in pricing. It would still require entrepreneurs and business owners to want to invest at that price point, but that would be passed on because it is a very competitive market. You have heard from both of us that we are deeply committed to growing our lending to the SME sector.
Robert Begbie: We have talked about the increase in competition, and that is a good thing for us. It makes us consider what our propositions are to customers and why customers would find those alternative forms of financing, whether it is through challengers, neobanks or fintechs. As a bank, obviously, we would welcome any ability to be more competitive, but there are many forms of being more competitive. Being more competitive in terms of the customer proposition and the customer experience is equally as important as being competitive on price. I have a couple of proof points on that. We are the number one bank for start-ups in the UK. We have close to 20% of that market. That is at an early stage of bringing customers and entrepreneurs in.
Part of this, and it has been talked about previously, is in terms of that ecosystem and how you create those customers, pull them through to become the high-growth customers of the future. We have looked at our proposition, and we are in the process of launching something called the innovation economy proposition, which is much more about how we target those customers that potentially have high growth, and have a proposition that helps them accelerate that. We are large banks and, naturally, we have silos, but this is a way to do that. We do not provide equity in the same way as Lloyds does, but we feel that we can help a little bit more, like the US model where you can identify those potential high-growth sectors and customers and drag them through. That is one of the ways.
We have 13 accelerator hubs up and down the UK, which are there to help develop entrepreneurs and high-growth businesses. We have announced recently that we will put 10 of them in universities in the UK. Our chief executive was in Leeds last week, signing the first one with York University. Again, it is about that ecosystem of research, start-ups, innovation and pulling companies through. Yes, they will need support from an equity perspective. There are many different forms of equity, and I think we would agree that equity outside London and the south-east is a common theme that comes back to us in terms of small businesses trying to grow. It is about how we can create that innovation economy and start to build not only internally but those customers that can look to then expand globally.
The Chair: I am afraid we have run out of time. All that remains is for me to thank you for answering these questions so well, as well as the questions that we did not ask you. It has been a very useful session, and we are very grateful to you for taking the time to come. We will have a short break before we begin the next session.
