23
Examination of witnesses
Lucy Rigby, Lowri Khan and Daniel Rusbridge.
Q173 The Chair: Welcome to today’s meeting, which is the 16th 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 you, Minister, Ms Khan and Mr Rusbridge for attending.
The 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 on the parliamentary website. A few days after this session, you will be sent a copy of the transcript to check it for accuracy. We would really appreciate it 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 any additional points to make, you are welcome to submit supplementary written evidence to us. Did you want to make anything by way of an opening statement, Minister?
Lucy Rigby: I will briefly, if you do not mind.
The Chair: Please do.
Lucy Rigby: It is a pleasure to be here for what is an important inquiry. As a Government, we have an ambitious strategy when it comes to financial services, which I know the committee is fully aware of. Entirely as you would expect, integral to that financial services strategy is the fact of UK banks continuing to be at the centre of our financial system, safeguarding customers’ deposits, enabling payments and, of course, being a vital source of lending.
We have set out that, in some places, post-crash regulation may have gone too far in seeking to eliminate risk-taking by banks. In saying that, I am acknowledging, of course, the increasing role that private markets are playing in financing the real economy, and I am very conscious that that has been the subject matter of this inquiry to date.
We are equally clear that the growth in private markets has brought about real benefits, including supporting innovation and diversifying sources of funding, and helping to ensure that firms can access credit and finance that suits their needs and, of course, alongside that, that risk sits in sectors that are able to manage it.
Clearly, alongside that, the growth in private markets comes with new risks, given the sector’s growing complexity and, in some cases, a lack of transparency and the links with the banking system as a whole. We, therefore, very much support the work that is being done by regulators to understand and mitigate those risks. This year’s forthcoming FPC remit will emphasise that the committee should continue to consider those risks in private markets.
The Chair: Thank you very much. Perhaps I could ask the first question. Do the Government consider that private markets could become systemically important?
Lucy Rigby: We are certainly alive to the growth of private markets. As I have outlined, we are clear as to the benefits of that growth, but also the risk. I mentioned the post-crash regulation, which has been a contributor to the growth in private markets, but it is not entirely about that. The fall in global interest rates and the demand for different types of lending have led to that growth as well, but I do not want to undercook the fact of us being alive to those risks. Indeed, you heard extensively from the Bank that the regulators are very much alive to those risks as well, and there are a host of things that, as you know, are ongoing to monitor and deal with that risk.
The Chair: I was quite impressed with the evidence that we had from the governor and the deputy governor, and very much welcomed the system‑wide exploratory scenario, which I think is what they called it. The timescale for that was somewhat extended. What would the Government do if they were to conclude that there is a systemic risk arising from private markets? Would you just leave it up to the regulators? What would your response be?
Lucy Rigby: Subject to anything that Lowri or Dan may wish to add, much would depend on the outcome of such a scenario. The system-wide exploratory scenario that you referred to, Chair, is not, of course, the only thing that is going on to monitor risks. The FCA and the FPC have undertaken a lot of work to look at risks in each of these areas, including in relation to insurers, for example, and private equity, looking at valuations. There is a range of things that have gone on, and I would fully expect that, whatever the results of any scenario, we would want to respond in a granular and detailed way, based on what comes out of that.
Lowri Khan: If I can add to that, it is worth just pausing a bit on the dynamics of the system-wide exploratory scenario—SWES, as people say—in that the outcome is the end of the process, but it is a process that is not just completed in one bound, but involves going out to firms, testing their responses to a particular scenario, and then iterating and feeding back on the results of that. You would expect that, in this planned private market SWES, that is the sort of process that the Bank will do, as it did for its first one, which was based on public markets.
The Chair: It has to rely on voluntary co-operation, though, does it not?
Lowri Khan: Yes, indeed, but, in both cases, there is a learning as you go through, and I would expect that we would get some of the preliminary findings, as, indeed, will firms themselves, as we go through that process.
The Chair: Minister, you mentioned the position of insurers, and we understand that private credit makes up a quarter of UK insurers’ assets under management. Are we doing enough to monitor the risks to the insurance sector that arise from these interconnections?
Lucy Rigby: It is entirely the right question to ask. We are aware of the increasingly complex arrangements that there are in this sector, but we have confidence in the PRA’s ability to monitor all of these risks and to deal with them in a way that protects financial stability. Most recently, the PRA looked at funded reinsurance but concluded that it did not want to put in place any new restrictions. It is right that we are aware of the potential risks in this area.
Q174 Lord Sharkey: Good morning. I have two questions. The first is to do with international regulatory standards. We have heard concerns surrounding a divergence in these standards as the US softens regulation and, in particular, the Basel requirements on capital and liquidity. How do the Government monitor and navigate these developments and perhaps even contribute to them?
Lucy Rigby: There is a range of things. The Treasury is constantly engaging with regulators on all of these risks. That is what happens at domestic level, but then, at international level, there is the ongoing monitoring work that the Financial Stability Board does. I could go through some of the things that the FCA and the PRA have looked at over the course of this year, but, if I might, I will invite my officials to come in specifically on the point of view of the international standards. Lowri, do you have anything that you want to add?
Lowri Khan: I can add a little. The purpose of international standards, which are overseen by the Financial Stability Board, is to recognise the global and interconnected nature of the financial sector, which we see very much in the case of private markets, as well as the banking system. It is up to each jurisdiction to implement those global standards. Part of what the Financial Stability Board does and what we do domestically is to monitor that implementation and consider what it means for stability and, indeed, for consistency of implementation.
Your question may have been related to banking and Basel III.1, as it is called, in particular. There, we have very much had an eye on consistency of implementation, which is why we have always thought it important to align implementation as far as possible across jurisdictions. That is why implementation has been delayed: to facilitate alignment in certain respects.
Lord Sharkey: Is it to facilitate or to wait for alignment? You say that the delay is to facilitate alignment.
Lowri Khan: Yes, exactly.
Lord Sharkey: How does delay facilitate alignment?
Lowri Khan: The point is so that we are very clear about what it is we are aligning with.
Q175 Lord Hill of Oareford: I have a follow-up point. You are explaining how we are trying to make sure that there is alignment through the FSB. Quite clearly, the Americans are not going to align through the FSB on private credit markets. It is not going to be a priority of theirs to regulate in this area, so where does that leave us?
Lucy Rigby: My understanding is that we are delaying precisely so that we can seek that alignment. We would need to deal with the situation as it comes.
Lord Hill of Oareford: I understand that that has been the case on Basel, but you are saying that that would be likely to be the case as to how we think potentially about regulating private credit markets if we conclude that that is necessary. I do not jump to the conclusion that we need to, but, if we do, does that same logic apply: that we would wait for the Americans to help us work out what we think should be done about private credit?
Lucy Rigby: Before I bring in Lowri or Dan, it sounds like I am with you, Lord Hill, in the sense that I would not necessarily jump to that conclusion either. There are good reasons why you would not want to jump straight to regulation, not least because, clearly, there are key differences between this sector and the regulated sector.
Daniel Rusbridge: If I may just add, since leaving the EU, we have developed a system of financial dialogues with a range of other jurisdictions. We have our UK-EU financial regulatory dialogue. With the US, we also have a financial regulatory dialogue. The purpose of those discussions is partly to build stronger connections and to foster some of those mutual trust arrangements, which are absolutely necessary and the bedrock on which the international financial services system of regulation relies.
It is also to have an eye on areas of development, in particular with the EU. Our financial services systems were aligned at the point at which we left, and it has its agenda and we have ours. It is important to understand, while we are all facing similar risks, what regulatory steps we are taking in response to those.
To follow up on what the Minister said, if there is regulation that happens in response to this, it will be in response to the risks that emerge, and it is a developing situation, as you heard from the governor in his evidence.
Q176 Lord Sharkey: I would like to move on to my second question, which is to do with shocks arising in United States private markets. Everybody has heard JP Morgan’s warning about more cockroaches, and the Governor of the Bank of England, in evidence here, took the view that alarm bells are sounding. What assessment have the Government made of the likelihood of a shock arising from the US private credit or life insurance sector and its effect on the United Kingdom? What steps would the Government take to respond to any such shock?
Lucy Rigby: I will not go to the specific companies that have been referenced; you will appreciate that I do not want to comment on those situations directly, not least because some of them involve not only ongoing proceedings but allegations of fraud, which are, you would hope at least, unique to those circumstances. The key here is, as you heard from the governor, the extent to which these are idiosyncrasies or symptomatic of something much wider. The straight answer is that we do not know yet, but we are alive to those risks, and cognisant, as I said at the outset, that there are specific circumstances in terms of what is going on in the US, at least as far as we know at this point.
Lord Sharkey: We were not prepared—I am not sure that anybody was—for the GFC, whether that stands for “great” or “good” or whatever. Are we similarly badly prepared for the prospect of a crash caused by events in American private markets?
Lucy Rigby: When I said that we are alive to the risk, we are particularly alive to the interlinkages, which, of course, is very important. Because of the regulation that was put in place following the crash, and the position that the regulated sector is now in, our banks are now well capitalised, and we have a mature and robust regulatory framework that can cope with these types of risks. As I said, the key thing here is that we, and indeed the regulators, are alive to those risks and conducting things such as the SWES, as well as other studies, to work out, in particular areas, the extent to which there is stress and whether anything needs to be done.
Q177 The Chair: Just following on from that, perhaps I misunderstood, but you appear to be saying that we can just wait and work out what the Americans are going to do or not do in respect of private credit. That would be a very unsatisfactory position, would it not?
Lucy Rigby: That is not quite what we are saying. We are saying that we are confident in the regulators’ ability to manage these things because of the mature regulatory framework that we have. In saying that, I do not want to appear as though we are, as I said previously, undercooking these risks. We are very much alive to the fact that there may well be these issues around a lack of transparency and interconnectedness, and we are working closely with the regulators to make sure that those risks are managed.
The Chair: It sounds a bit passive and not very active.
Daniel Rusbridge: If I may add, the Minister is exactly right. This is not about complacency. The role of Government is to ensure that our regulators have the necessary tools in order to act, be that retrospectively or, indeed, proactively. The Bank of England and the FCA have already taken action. For example, the FCA has taken action to increase the transparency and robustness of some of the valuation practices. It saw some shortcomings there and was able to act. If there are areas where the regulators feel that their toolkit is in any way lacking, that then creates a role for the Government potentially to bolster that toolkit. So far, there are no obvious areas where that is lacking, and I hope that you were reassured by some of the evidence provided by the governor that they do have a very proactive agenda in this area.
Q178 Lord Hollick: Good morning, Minister. You said in your opening remarks that the banks are at the heart of our financial system. With growth being top of our agenda, they are going to play a very important part, but they are playing a smaller part now than they were 10 or 20 years ago, and a very muted role. The private finance system is growing at 40% per annum at the moment, and is providing a significant amount of credit to the economy, but it is unregulated.
On the one side, we have a more heavily regulated financial system, quite properly tightened up after the crash, and the market has responded by having a private finance system, which is largely unregulated and which is opaque. Indeed, when the Governor of the Bank of England came before us, he acknowledged that a lot was suspected but little is known.
I think that you have expressed today that you are currently relatively relaxed about this. On what do you base that judgment, given that we have little information about the connectedness between banks and private finance, that a lot of it is offshore, and that there is very little data? Could you tell us what information the Treasury needs to remain relatively relaxed about what is a dramatic shift in the provision of credit to this economy?
Lucy Rigby: If I may say so, you are entirely right to point out those shifts. As I hope I have made clear, we are very cognisant of them. I do not know if “relaxed” is quite the right description that I would be happy with. I hope that I have been able to emphasise today—and, if I have not, then I should underscore it—that we are cognisant of the risks in this space. We are working with the regulators to monitor them. I do not know if that necessarily equates to being relaxed, and certainly not entirely relaxed.
You mentioned data and the lack of data. Again, I referred earlier to the lack of transparency, but the lack of data is clearly part of that. In certain areas of the non-bank system, there are clearly very significant data gaps, and certainly, it is fair to say, where you are crossing jurisdictions. That is entirely why—you heard this from the governor, if I am correct—we are working both domestically and internationally to try to ensure that we acquire the data that we and the regulators need to better assess some of those risks.
That emphasis on data is about trying to do that in a proportionate and targeted way, because we are cognisant in a wider sense of the regulatory burden that is on financial services firms at the moment, and trying to cut that down. That is just one part of the monitoring that is ongoing.
Lord Hollick: Which information particularly are you seeking in order to confirm your current stance towards private finance?
Lucy Rigby: There is a range of things. The fact of the interaction between private markets and insurers has been raised and, as I said, the PRA is doing work there, but that is part of a range of things. The FCA looked at private market valuation practices, and it is right to say that, in general terms, it found that practices are working well, but it is considering some of its findings in future work that it is going to do.
As you heard from the Bank, there is a programme of upcoming work from the Bank, not least the further SWES, which will focus on some of these risks and trying to acquire greater data to enable greater analysis.
Q179 Lord Eatwell: Good morning, Minister. One of the difficulties that this committee has faced in its discussion of these and other issues is that the word “investment” is used in a variety of ways. For example, the banking sector will tell us that it has invested several billions of pounds in the UK economy. What it means is that it has bought secondary assets worth several billions. It does not mean that it has bought machines or trained workers or invested directly.
If we make clear this distinction between investing in secondary assets or existing assets, another example is, “We boost the ability of lending to first-time buyers in the housing market”, which simply pushes up existing house prices. It does not build any more houses. This is one of the puzzles in understanding the Government’s position on financial sector risk and reform. Do the Government have any evidence at all that this will increase real investment? If so, where can we access that evidence?
Lucy Rigby: It is a good question. If I may just clarify—that what will increase real investment, specifically?
Lord Eatwell: Real investment means real stuff such as building factories and machines and training workers, not buying secondary financial assets.
Lucy Rigby: Was the question about what will lead to increased real investment?
Lord Eatwell: Will the Government’s financial reforms, which are encouraging the financial institutions to take more risks and so on, result in simply more credit finance flowing into secondary markets? What evidence is there that it will increase growth, which means investing in real stuff?
Lucy Rigby: Looking right across the financial services strategy, the aim is to increase investment across the board in the UK. I was in Singapore last week, pushing this new concierge service that we have—the Office for Investment: Financial Services—which is pushing real investment, as you would put it, in specific projects here in the UK. There are other ways in which greater investment in financial services benefits the real economy, not least in terms of jobs and, indeed, the growth of the sector more broadly, which leads to, in theory, more credit being available. There are a number of ways in which the growth of the sector leads to real economy benefits.
Lord Eatwell: If you look historically, there is no evidence for this at all. Is there any evidence in the academic literature, for example, that changes in the availability of credit result in economies displaying higher investment rates in real stuff?
Daniel Rusbridge: If I may add, there are two components to your question. One is about the secondary market, and the other is about the supply and demand for credit in the real economy. That was by reference to the Government’s strategy in relation to financial services.
As you will know, there has been well-publicised disappointment about the performance of UK capital markets over the last five years or so, in particular in relation to the US. What the Government have been doing is a series of thoughtful reforms to improve capital markets, which are the other side of the picture from what we are discussing here today, with the idea that a healthy secondary market can increase the depth of liquidity and, therefore, make it more attractive for businesses to make their initial public offering here, secure that investment, and plough that money back into the UK by way of productive investment. In relation to your question about secondary markets, there is a range of things there.
The other question that you have is about whether the supply of credit will drive demand. It seems that there is a separate set of questions there about how you create the demand for businesses to borrow in the first place. What we are mostly talking about here from a financial services perspective is ensuring that the market and the system work well such that those businesses—SMEs and others—that are seeking finance, either by way of bank lending or through alternative, non-bank lending, have a vibrant market to draw upon and have access to the credit to meet their needs. There are two dimensions to it.
Lord Eatwell: It would be very nice if markets worked well, but how are the reforms making markets work better in terms of supplying credit, particularly to SMEs, as you pointed out?
Daniel Rusbridge: Is your question about the banking market or about non-banks?
Lord Eatwell: It is both, really, because we are looking here at a phenomenon where banks have, to a degree, withdrawn from lending to the economy directly. They supply a significant proportion of their funds, which have very low risk weights, to the private capital market, and so lend indirectly. Does any of that increase the availability of finance to, let us say, SMEs? Is there any evidence that it does?
Daniel Rusbridge: It is certainly true to say that a diversified market is more resilient and provides new opportunities for businesses to borrow. It is worth saying that 80% to 90% of SMEs classify themselves as happy non-seekers of finance and so are not actively looking for borrowing in the first place.
Lord Eatwell: I am not sure about that. On a previous inquiry, we had in front of us a series of small, innovative fintech firms. Five of them turned up. They were companies that we really feel are doing good for the British economy. Fortunately, all of them had got their second round of funding of around $50 million to $70 million—in all cases, in dollars. In all cases, they had got their funding from the United States. There is no evidence at all that reforms here, or indeed the structure of institutions here, are providing the finance. They have to go abroad. Eventually, of course, they are sold off and then are not British companies anymore.
Lucy Rigby: There is, without doubt, a lot of US funding in fintech specifically. It is worth me bringing up the British Business Bank and the extra capitalisation, which has increased its total financial capacity to £25.6 billion now. There have been reforms alongside that to reduce the limitations on funding such that SMEs can access more funding. Since 2014, 36 licences have been given to SME lenders. It is an aim of the Government to ensure that SMEs can access more of the funding that we need.
Alongside the British Business Bank, we are consulting at the moment—in fact, the consultation has just opened—on improvements to the bank referral scheme, for example. There are a range of things that we are doing to try to make sure that SMEs get access to finance, because we recognise the important role that they play in the growth of the economy.
Q180 Baroness Bowles of Berkhamsted: I would like to probe a little further into some of the things that we have already been talking about and, in particular, around what equity is and what lending is, because they seem to have got merged. The Mansion House compact talks about investing equity in businesses, but the trumpeting around equity investment is the notion that it is equity, not lending, that finds its way into growth companies. Therefore, you want that trickledown. You do not want it to be equity pumped in to fund organisations and businesses that then use that in order to finance lending so that it is at the level of the growth business and they are saddled with lending in the same way.
One of the reasons why many small businesses are averse to lending is because it has unreasonable conditions attached to it. Their livelihood is already at risk in a business, and then they get asked to make the home that houses their children at risk as well, which is not exactly ethical if you just come down to it. How many people in this room have done that? That is what we seem to expect. I am interested in whether it going to be equity going in, in particular when it comes around to encouraging pension funds to be investing. Is this going to be by way of real investment into companies?
Lucy Rigby: It is about both. Just to deal first with the point that you raised about putting personal guarantees in place for the purposes of guaranteeing lending, which I think was what you were referring to, we are very much aware of that phenomenon. There are circumstances in which personal guarantees can be appropriate—for example, when companies do not have assets. That is something that we are alive to, and we are working with stakeholders to try to make sure that people are not put into the inappropriate circumstances that you referred to. I think that I am right in saying that there is a code of conduct that is being worked on in that regard.
Baroness Bowles of Berkhamsted: I would like to intervene there, because that means that nobody is prepared to accept risk. They want to put it all onto the business owner. It is not risk when you are lending to somebody and you say, “We are going to take your house if you cannot deliver”. How about risk being more spread about?
Lucy Rigby: That is a valid point, but, as I said, we are working with the lenders, because we do recognise that this is something where guarantees can be asked for in circumstances that are less appropriate. Therefore, it is right to look at things like a code of conduct that may well allow the other steps that are being taken. I know that you have referred to it in other evidence sessions, and I wanted to acknowledge that we think that it is important.
Your question was a broader one, though, about the balance between equity and lending. As I said, it is about both. Dan referred earlier to reforms that we are making to capital markets, which are important. There are reforms to PISCES, as well as things that we are doing to the listing rules and the prospectus rules, which, again, are an important part of the strategy.
You referred to pensions and, indeed, to the Mansion House accord, and the reforms that my colleague Torsten Bell is making via the Pension Schemes Bill to DC schemes. The aim, as you know, is to enable more investment in productive assets, which we hope will be beneficial for the economy overall.
Baroness Bowles of Berkhamsted: I am a little afraid that, as with Lord Eatwell, a lot of this is secondary, not primary, and that new equity is still lacking. An important part of whether you are getting an investment of any kind, either on the debt or the equity side, is valuations. You said earlier that the FCA had been doing some work on this and seemed to be relatively happy, but we have had evidence that there is concern about the veracity of valuations of private market assets and, associated with that, concern about the use of third-party credit rating agencies.
I find those statements a bit odd, in a way, because is it not better to have a third-party valuation rather than your own, where you might have a conflict of interest, shall we say? That is part of the point of having credit rating agencies. If there is not confidence in third-party credit rating agencies, is there something wrong with the Credit Rating Agencies Regulations? Should they be being looked at sooner than they might otherwise be?
Lucy Rigby: Just to deal with the valuation piece first, when the FCA looked at that area last year, it did find good practice, as I referred to earlier, but it also found conflicts of interest, which you mentioned, and issues with ad hoc valuations. I cannot immediately recall now, but I am sure that there was another area. I know that the FCA was taking those findings away to feed into its further work.
Credit rating agencies are clearly an important link there. They are not, of course, the only means by which assessments are made. I do not want to comment on specific agencies or, indeed, specific assessments, but CRAs are, as you know, independent and regulated by the FCA. It is incredibly important that, when ratings are allocated, it is done in an independent and entirely objective way. We would wholly recognise the importance of that. This is where we link to the valuations piece of work. I am not aware that there is work going on to look at the regulations, but Lowri will correct me if I am wrong.
Lowri Khan: The risks that are associated with the use of rating agencies are very much on the radar. It has been highlighted in some of the recent cases in the US. There has also been a lot of focus in the US on the use of some of the secondary rating agencies by insurance companies in their capital calculations. This goes to the heart of some of the risks to do with the opacity of credit quality in some of the private markets.
It is very much in focus for further work as we learn the lessons from some of the recent events, but, at the moment, there is no concrete proposal to review credit rating regulations in the UK. That is very much an area that we are focused on in terms of understanding the risks and whether anything needs to be done.
Baroness Bowles of Berkhamsted: Are you saying that the concerns that we have picked up in evidence are possibly to do with the US situation rather than valuations in the UK?
Lowri Khan: I did not say that, but it is important that we learn lessons from the US, which is where a lot of these concerns have been raised.
Baroness Bowles of Berkhamsted: Credit rating agencies were part of the problem in the great financial crisis and, in particular, in the context of securitisations, where it is quite difficult to keep track of what is where and what the risk is in the slice and dice. There is now quite a lot more securitisation going on in the UK. This is not an area where we can look to the US and say, “It is all over there”, because, in fact, they have stricter rules around securitisation than we do. What inherent risk do we have in and around ratings and securitisation here?
Lucy Rigby: Securitisation specifically is something that the Treasury looked at three or four years ago. It also reviewed some of the post-crash reforms that have been put in place to check that they were still fit for purpose. I was not at the Treasury at the time, and my officials will correct me as to the conclusions, but I think it is right to say that the review in 2021 concluded that the protections that had been put in place remained important and, therefore, ought to remain in large part, but that there might be some areas around the edges that could be considered for reform.
Baroness Bowles of Berkhamsted: In view of this additional element brought in by private credit and the banks going to more securitisation, which has probably happened since that work, should it be pursued and looked at again, now-ish?
Lucy Rigby: I might turn to my officials, not least because I do not know the extent to which the review was caught in time, if you see what I mean, or if there was any future-looking aspect.
Lowri Khan: I cannot answer that question directly. The whole issue of valuations and transparency is an active area of exploration now. I would not look ahead and say that that will definitely mean that we will find that we need to change our regulatory regime, but it is actively being looked at.
Q181 Lord Grabiner: I have a couple of points that I would like to ask you about. First of all, arising out of Lord Sharkey’s question, in terms of what I would call plan B, which is in anticipation of another horrible GFC on a worst-case scenario, can we assume that there is a continuing dialogue between the Treasury and the regulators, and that you are not exclusively reliant upon the regulators to blow the whistle or let the red lights flash in the event of an anticipated similar catastrophe?
Lucy Rigby: As to the first point, you can certainly assume that there is a continuous dialogue, which is, I hope, entirely as you would expect. As the Treasury, we have a role in overseeing things. That is clearly not in the supervisory and granular way that the regulators do, but we would consider ourselves to have an important role in the process, and I say that as to financial stability more broadly.
Lord Grabiner: I hope so.
Lowri Khan: If I can add briefly to that, there are various formal ways in which we have a role, and there are more informal ways in which we have an ongoing dialogue. In particular, the Financial Policy Committee has a Treasury member. They are a non-voting member, but that means that we are present at all the meetings of the Financial Policy Committee and very much in the swim of those deliberations.
We are also present in the global Financial Stability Board as well. We do not just leave it to the Bank and the regulators in those fora. We spend a lot of time on cross-authority dialogue with the Bank, the FCA and the PRA. That is a daily matter. It is not a quarterly meeting for a catch-up. In that engagement, we focus particularly on some of the specific risks as well as on potential policy matters that might be pursued.
Lord Grabiner: That is very good. It is good to know. My other point was touched on by Lord Eatwell, and this will be very close to the Minister’s background as a competition lawyer. We have been told that bank lending through private credit only requires the individual bank to hold 20% of the risk-weighted capital, whereas, if banks lend directly to a company, they have to hold 100% of that capital. I am just an ignorant lawyer, really, but you are a competition lawyer, and you probably know the answer to this question. What is the justification for that discrepancy?
Lucy Rigby: Across the board, there is an acknowledgement that the banking sector as a whole is competitive, which is to the benefit of the wider economy. As to the stipulation that you are pointing to, Lord Grabiner, your suggestion is that it creates an uneven playing field. Is that right?
Lord Grabiner: It encourages banks that want more flexibility on their lending book to lend to the private market. They will be discouraged from lending because they would have to hold so much more capital to justify the loan. What I do not understand is why there is that discrepancy in the first place. There may be some economic explanation, but I am not quite sure what it is. Do you know?
Lucy Rigby: It is right to say that capital requirements right across the board—as you know, there are different requirements that apply to different levels of the stack—are put in place with a view to the size of specific banks and their specific lending activity. You will know that the FPC is reviewing capital requirements, and that review comes on the back of reforms that have been made recently, including to MREL. Because of the FPC review and reforms that have been made, there is an impetus for making sure that the banking sector is as competitive as possible, and we recognise that capital requirements are a piece of that.
Lord Grabiner: Finally, if that split of 20% and 100% is accurate, is that a source of concern to the Treasury? Does it give you concern because of the lack of knowledge about what is going on there in terms of potential exposure and potential risk?
Lucy Rigby: Lord Grabiner, I am going to turn to my officials on that. It is not something that has been raised with me in this context.
Lowri Khan: I cannot comment in detail on the specific capital that is held against specific investments.
The Chair: Why can you not comment on it?
Lowri Khan: I am not aware of the specifics. It will be context-specific.
Lord Grabiner: It is a pretty basic point, is it not? You must have thought about this. I hope somebody has thought about it.
Lowri Khan: Yes, indeed. To be clear, the way that risk weightings are applied generally to bank lending is an active area of consideration. There is ongoing work, for example, in the context of the PRA, thinking about how internal models can be made more accessible to smaller banks in particular, so it is definitely an active area.
Lord Grabiner: My question is slightly different. Should we be concerned about the fact that a lot of money is going from banks into what we call private credit? We do not have any visibility of what is going on in that marketplace. At the moment, banks are, presumably, also encouraged to lend more to that marketplace because of the much better risk weighting commitment that the individual bank is confronted with in respect of that lending profile.
Lowri Khan: That is understood. Clearly, we would be concerned if there was anything very distortionary going on.
Lord Grabiner: But you do not know that, or do you?
Lowri Khan: There are several dimensions to this. One is what it means for the safety and soundness of banks. A lot of work is being done in the context of the regular bank stress testing that goes on to ensure that those exposures are being managed.
Lord Grabiner: That goes to the position of the individual bank.
Lowri Khan: Yes, indeed.
Lord Grabiner: The bank is being stress-tested in terms of what its book looks like and, if things go wrong, what is going to happen to the book. What about what is going on outside in terms of the borrowing in that private marketplace?
Lowri Khan: You are right that the stress testing looks at it from the bank’s perspective, but it does consider the bank’s ability to manage its exposures. There has been particular work by the PRA to try to think about how well individual firms are managing their exposures in the round.
Q182 The Chair: We had evidence spelled out quite clearly from HSBC and Lloyds, and it is perhaps worth looking at. I am a simple soul, but it seemed to me that what they were saying, as Lord Grabiner has pointed out, is that banks are there to make money. If you have to set aside less capital by lending to private markets and by lending directly, that is what is going to happen, and that might explain why there has been a big growth in private capital. When you say that you do not want to comment on the detail of this, it is absolutely fundamental, is it not, that the capital rules are encouraging banks to lend in areas that are not regulated? Therefore, you have a kind of Maginot line. Is that not right?
Lowri Khan: Just to correct that in terms of what I previously said, I did not say that I could not comment on the issue. I meant that I could not comment on the specifics of the risk weighting percentages that Lord Grabiner mentioned.
The Chair: Do you mean the actual numbers?
Lowri Khan: Yes.
The Chair: The position is that there is a huge incentive to lend in private markets, and the result is that traditional banking is not going to help SMEs and so on. Do you agree with that?
Lowri Khan: I do not doubt that private credit has grown and that higher-risk lending has grown as part of that growth in private markets. Going back to what the Minister was saying earlier and, indeed, what you heard from the governor, it is a response to some combination of low interest rates and bank regulation that has meant that you have had a shift of risk into private markets. I would, though, say that a lot of lending to corporates is still done from within the banking system. It still accounts for the vast majority of loans to corporates, so it is certainly not the case that the incentives are such that all of the banks’ firepower has been drawn by the private markets.
Q183 Lord Lilley: I wondered whether now would be the time to raise a point put to us by the previous Governor of the Bank of England, Lord King. He said that he thought it would be better if the regulation of the banks were to focus on ensuring that they had adequate capital backing and not specific, detailed control of their lending book through setting X per cent for this and Y per cent for that.
Another similar issue has been raised by you, Chair, that there are very high reserve requirements if you lend to someone building a house, but very low requirements if you lend to someone buying a house. The result is that most banks’ books are lending on mortgages, not on building houses, although it is the same asset underneath it. Would you go off and think about Lord King’s suggestion that we stop trying to fiddle with directing lending by different reserve requirements for different kinds of lending, but just make sure that banks are properly capitalised?
The Chair: His point was that it would be better to look at leverage ratios rather than risk weights.
Lucy Rigby: For very obvious reasons, I would want to pay full and good attention to anything that Lord King has said. The position at the moment with having the leverage ratio and risk-specific rules is such as to provide better protection from a financial stability point of view than if we were just to rely on the leverage ratio. There would be concerns if we did move just to the leverage ratio.
Lord Lilley: That is what he was querying, of course. Having held your job in the past, the one piece of advice I was given is, “Always remember that the regulators regulate in the interest of regulators”. Therefore, they will always want to extend their power, their control over detail, and try to avoid blame. Your job as the Minister is to make sure that they do not do all that and they just have a proper, simple system within which people can work, in a competitive way, to the benefit of the economy.
Lucy Rigby: That is noted.
Q184 Baroness Noakes: I am going to stay with bank capital, but I am going to move away from risk weightings. Some of my colleagues do not seem to share my confidence in the fact that risk weighting is the right way to basically calculate capital, but we will debate that amongst ourselves at a later stage.
I want to concentrate on money going to SMEs. We have had evidence from a number of mid-sized banks that say the way the capital rules work means that they have to carry too much capital, which does not reflect their own loss experience. That is through a combination of things, such as having to have a countercyclical buffer set by the FPC and not being able to access the IRB approach to risk-weighted assets, which forces them back on the standardised method, which raises the amount of capital that they have.
The Government—all Governments, not just this Government—have, as a matter of policy, handed all of these decisions over to unaccountable regulators or other bodies. The FPC is not a regulator but the PRA is. There then becomes a problem of the banks saying quite clearly that they could lend more if they had capital requirements that were more attuned to the actual risk that they undertake, but the Government cannot do anything, and yet the Government have a growth mission and must want to see finance flowing adequately, particularly to the SME sector, which is so large in terms of employment in the economy. What do the Government think is the right way forward on this?
Lucy Rigby: That is an excellent question to ask. As I referred to earlier, and as you allude to, it is a priority to try to get more lending into SMEs. There is an interesting cultural question, relative to other economies such as the US, for example, where lending to SMEs is just different. As my colleague Dan referred to earlier, there is, to some extent at least, a demand question when it comes to SME lending over here.
As to the various things that the Government are doing, I mentioned the British Business Bank earlier. Having that £25.6 billion total financial capacity, and relaxing some of those limitations on lending will help SMEs. There is also the bank referral scheme. There is also an advice and guidance scheme for SMEs when it comes to lending. There are a range of measures that we are taking.
Baroness, I apologise if I am capturing something from your words that you did not intend, but I was not sure if you meant on Basel III.1 necessarily. When we have heard it raised previously that those requirements restrict SME lending, our analysis is that they do not. There is also the ring-fencing piece of that. I have heard it suggested previously that ring‑fencing is limiting, vis-à-vis SME lending. It is right to say that the recent review of ring-fencing—we are looking at it again—concluded that, at that point, ring-fencing was not thought to unduly limit lending to SMEs. There are a range of things that we are doing, because we recognise the importance.
Baroness Noakes: The British Business Bank has only lent to 62,000 SMEs. There are 5.5 million SMEs in the UK, or 1.5 million if you take the one-man bands out of it. They are a drop in the ocean, so the Government are not actually doing very much in that territory. I was actually trying to get at whether you thought the Government ought to be taking a more proactive stance with the way in which capital is set for some elements of the banking sector. Do you think you have a role, or does delegating it remain the right solution?
Lucy Rigby: Across the board, our view has been that these questions are best addressed by the independent regulators. Those regulators are independent, but it is not true to say that they are unaccountable.
Baroness Noakes: The FPC is not accountable.
Lucy Rigby: We see in the Chancellor’s remit letters—and you will see in the further remit letter, which is going to include reference to overseeing the risks in private markets—the areas on which she would want the regulators to focus. Growth has been a very clear focus in those letters. Of course, the regulators have their growth objectives as well. I am not sure that I agree with the premise that we need more control over those areas.
Baroness Noakes: It is a question of whether you think you need levers to help growth come into the economy. If you delegate, you are taking the judgments of regulators who are often quite risk-averse, as we have found in our earlier studies.
Lucy Rigby: I entirely take the point, but at the heart of the financial services strategy is this change in attitude to risk, such that we are asking the regulators to regulate not just for risk but for growth as well. There are a range of things that the regulators are doing to respond to that. I will not take you through them, for the benefit of time.
Q185 Lord Hill of Oareford: I have a general question, which follows on a bit from Lord Grabiner and a bit from Baroness Noakes. When you come into the job and you are trying to take a view as to what you think has been going on and where you want to spend your time and prioritise things, do you reflect on the effect of this issue that we are talking about? There is one classic way of responding to people being anxious about private credit markets, which is to say, “We had better do something”. There is another way to think about it, which is about some of the things that we have been exploring, such as the linkages between the growth of private credit markets and previous regulatory decisions, and the whole cumulative effect of regulation from 2010 onwards.
Do you have any early reflections on what the cumulative effect of that banking regulation might have been? You have referred a bit to some of the work that is going on with the FPC and so on. I am just interested to know whether you think, instinctively, that part of the answer to the question of the growth of private credit markets might be looking again at banking regulation and rowing it back in certain areas, particularly, for instance, in terms of the effect it has had on banking lending, as Lord Grabiner was saying. Alternatively, do you think, “That has been done. I now need to look at all these new regulatory risks in this new area”?
Lucy Rigby: It is the former. That is the shortest answer, but I will expand on that. This is not a view that is unique to me, but it is right to do exactly as we are doing, which is to look again at the post-crash regulation. As Lowri and I referred to earlier, there is a recognition that it may have gone too far in some areas. The growth of private markets is one consequence of that, but there are others. It is entirely right to look at post-crash regulation again.
I mentioned earlier the ring-fencing review. We are hoping to publish that at the beginning of next year. There are things that we are looking at, with a view to ensuring that regulation across the board when it comes to banks is proportionate and appropriate to the circumstances in which we find ourselves.
Lord Hill of Oareford: It does not look as though it is in this particular case, for some of the examples Lord Grabiner used, does it?
Lucy Rigby: As we responded to Lord Grabiner’s questions, there are reviews going on. On the specific 20% piece, that is something that I will take up and have a closer look at, because that is the right thing to do.
Q186 Lord Hollick: Staying with your early reactions and thoughts, the Treasury has imposed a 25% reduction in the budget of the regulators, to be achieved by the end of this Parliament. Given all of the complexities that we are talking about and the areas of unknown, is that a realistic objective, if the regulators are to be able to continue to look into all of these issues?
Lucy Rigby: The objective is to reduce the administrative costs of regulation by 25%, and both the FCA and the PRA have already taken steps to identify some of the areas in which regulation will be reduced. Was the implication of the question that that will somehow be detrimental? I think there are positives, actually.
Lord Hollick: I am asking what the behavioural consequences of that are. How will they prioritise certain things? In the course of this meeting, we have raised quite a lot of serious issues that have to be looked at by the regulator. Will they have the resources to do that once they have made these cuts?
Lucy Rigby: They will have the resources. In terms of cutting back on regulation specifically, the idea is to cut back on the administrative burdens stemming from regulation which are unduly burdensome, not to impact on any of the serious matters that the committee is considering.
You referred to the behavioural impacts. We would hope that the behavioural impacts of cutting back on undue regulatory burdens are such as to increase productivity and growth in all the ways that you would hope, if, as a business, you were not spending time on unnecessary reporting, because you are able to do other stuff.
Daniel Rusbridge: Your question is partly also about their budgets. The regulatory budgets are set by the regulators themselves through a consultation. Their resourcing, business planning and prioritisation is a matter for them, which they decide independently of Government. The FCA has just set out its five-year plans on how it intends to deliver within that envelope.
Q187 The Chair: I am confused by this. When you say that you think that, following the financial crisis, risk weightings or capital requirements were set too high, are you just relying on the regulators to come to that conclusion, or are you actually going to direct them?
Lucy Rigby: I hesitate to answer. The Chancellor has set out that she wants the outcome of the FPC’s review of capital requirements to be meaningful. “Meaningful” is the same word that she has used vis-à-vis the ring-fencing review. As to the specific direction that has been set, I imagine that is captured in language that I do not have.
The Chair: What does “meaningful” mean? Perhaps you could let us have a note, having reflected on it.
Lucy Rigby: I can do that. In relation to ring-fencing specifically—
The Chair: I do not mean on ring-fencing. I mean on capital requirements.
Lucy Rigby: In that case, we will provide a note.
The Chair: To give credit where credit is due, you have taken some steps on MREL, but the questions that are arising this morning have been around for as long as I have been interested in financial services, which is quite a long time.
Q188 Lord Vaux of Harrowden: I was going to come back to the SME question, if I may. I have two questions. First, in your introductory statement you referred to how private markets have an important role in financing the real economy. We have had that debate. You also referred to them providing diversified and increased sources of funding, but that is not true for SMEs. They have not stepped into the £65 billion funding gap that has been identified at all. I am curious to understand why you think that private credit has not moved into that gap in any shape or form.
Secondly, the other evidence we have received is that part of the problem with SMEs is the reduction in relationship banking, as branches close and are automated. We have been given the example of Handelsbanken in Germany as a successful relationship bank. We have been given the example of community banks in the US as well. What, if anything, should we be doing to improve the relationship banking that SMEs rely on when it comes to taking a decision around borrowing?
Lucy Rigby: On the second of those, a good deal of emphasis—indeed, a good deal of emphasis in the Commons among my colleagues—is put on relationship banking and the importance of our manifesto pledge to have 350 banking hubs over the course of this Parliament, because we do very much appreciate the value of face-to-face banking. Of course, banking hubs are only necessitated by virtue of banks falling away. As I know is well appreciated, the nature of banking has changed so substantially. The move in the number of people who are now banking online is gargantuan, but nevertheless we very much appreciate the importance that many people still place on face-to-face banking, hence the pledge on banking hubs.
On SME lending specifically, I am going to hark back to the demand question. SME lending in this country is just different. There is less SME lending here than there is in somewhere like the US. That is quite a stark difference. As to the growth in SME lending, the vast majority of it still comes from the banks. The new SME lending in recent years has largely come from challenger banks. I think that is true to say.
Your question specifically, though, was about why we are not seeing private market lending going to SMEs. I am not sure if I have an explanation for that. I might turn to Lowri.
Lowri Khan: It is an area of interest. Among the things that the Government have asked the FPC to look into, it is this question of how well the financial sector as a whole is serving the needs of the UK economy. Within that, the role of SMEs is a particularly important one. Clearly, a lot of private credit is directed at larger firms. Structurally, there is a question there about why there is not better access for SMEs.
Lord Vaux of Harrowden: You mentioned that the US is doing it better than us. For whatever reason, we are not getting lending into SMEs. What studies have you done to show whether that is having an effect on our growth? Is there actually a problem here, or is it one that we are imagining?
Lucy Rigby: The fact of us appreciating the need to get greater information to SMEs, and enable greater SME access to finance, is symptomatic of the fact that we recognise that as a lever. That is acknowledged. The broader point is about whether we need to do more and put more emphasis on it, and perhaps we do.
Q189 Lord Lilley: I want to return to the subject that Lord Eatwell was raising earlier about the amount of real investment that we are encouraging and promoting. There is a given amount of savings at any point in the economy, which means that there is a given amount of investment, because savings equal investment. Therefore, if there are more savings financed by bonds, there is less by equity. If there is more financed by private investment, there is less by the banks than would otherwise be the case.
I put this to someone from one of the major banks—you may have seen the evidence—and he said my premise was wrong, that there is not a fixed amount of saving and that the amount of saving and investment in the economy has doubled in recent years. I said, “Why aren’t the Government making something of this?” He said, “I do not know. They should, because it is a good thing”.
If he is correct, that is a good bit of news for you. Could you also work out why the investment has doubled, where it is going and what assets it is in? Is it genuine investment? Is it domestically financed, or is it financed from abroad? Is it investment abroad rather than at home? It seems to me that this is pretty fundamental. If our biggest bank thinks that the amount of investment has doubled, we should know more about it.
Lucy Rigby: I agree. I welcome this good news. It is not entirely news, I should say, but I certainly welcome it. Indeed, perhaps we ought to be making more of it. Perhaps you will see that in the coming days.
Q190 Baroness Donaghy: I know we are in “how to tame a tiger” territory, and I appreciate that you have to give answers that are extremely careful, shall we say. The overall impression I am getting, as the Chair said earlier, is that it is all sounding a bit passive. It is all about reviews, consultations and not really digging down into the unknowns.
One of the witnesses that we had earlier said the reason why a lot of the bright young things are leaving banks to go into the private sector, into this private investment area, is that it is extremely exciting, not just because it is not regulated but because there are no limits to what can be achieved. I think that is what he said. A year before, he told colleagues, “No, that cannot be done”, and then a year later it could be done. I do not know if he was saying that to reassure us, but it frightened me to death.
Yes, you have to be careful to this committee, but are you really fully seized of the potential that is being used and exploited by this new world of private investment? I have another specific question about the remit letter that you referred to, which I can ask in a minute.
Lucy Rigby: As I clearly did not make clear enough earlier, I do not want to sound unduly passive about some of these risks, which is why I have emphasised the extent to which we are working with the regulators to monitor them. There is an awful lot of work that has gone on and an awful lot of monitoring that is ongoing, including in specific sectors, as we have talked about.
I do not wish to cause you even more alarm, so I hope that I do not, but it is right to say that in our financial services growth strategy we do put emphasis—as you would expect, because London is as good as we are at this—on portfolio management, asset management, venture capital and private equity. I can appreciate why the person that you were speaking to finds it an exciting environment to be in, because in many ways it is, but that is not to say that we are in any way passive about any of those risks that arise from the growth in private markets.
Equally, to come back to a point that was alluded to earlier, I also do not think that the right reaction to being aware of risks is to jump to regulation. There are really key ways in which private markets are different to banks. These are not taking customer deposits, for example. The situation is different, and it is appropriate for us to treat it differently.
Baroness Donaghy: You referred earlier to a future remit letter, which was going to ask for further examination of risks. Would you like to say a little bit more about that?
Lucy Rigby: My understanding is that the upcoming remit letter will specifically refer to private markets. I am afraid that is subject to my officials telling me otherwise. That is the information that I have at this point. I simply said that as a means by which to demonstrate that we are alive to these things, and indeed we are suggesting to the regulators that they should be alive to these things.
Baroness Donaghy: It is not a change in emphasis or policy.
Lucy Rigby: Without having seen the exact wording, I hesitate to answer.
Lowri Khan: We send an annual remit letter from the Chancellor to the Financial Policy Committee, which sets out the Government’s thoughts on priorities that they should be pursuing. Those have long been very focused on the risks that might arise outside the banking system. There has been long and very productive work on how we both understand and address those. The intention within this forthcoming remit letter—these letters are typically issued at the time of the Budget—is to have a specific reference to private markets, given the very strong interest that we have in that.
Q191 The Chair: On that point, your message to the committee is that you are alive to the risks. Could you just tell me which risks you are alive to, and what are your known unknowns?
Lucy Rigby: There are key areas of risk that the FPC has highlighted as well, those being the interconnectedness of private markets with the regulated sector and the complexity of some of the arrangements that are being put in place. In specific areas there is a lack of transparency. To the extent that there is no overlap between those three things I have mentioned, they would be the three things.
The Chair: What are the known unknowns? Perhaps your officials could help. What do you lie awake at night thinking about?
Lowri Khan: The big unknown is data, in the sense that, if you do not have the data, that is a known unknown.
The Chair: What are you going to do about that?
Lowri Khan: There is ongoing work. It is very cross-border in nature, as you will appreciate. In the context of the Financial Stability Board in particular, there is a lot of work going on to try to work that through. Going back to the system-wide exploratory scenario, by its nature that will collect data on a voluntary basis, which will further illuminate some of these issues, I would hope, and provide some insights into where those unknowns lie.
The Chair: Minister, thank you very much. That has been a really interesting session. It is great to see that you are so on top of your brief, despite the fact that you have only had a short time to be so. We are very grateful to your officials for answering our questions. That concludes this public session of the committee today.
