Oral evidence: SME Lending, HC 204Tuesday 1 July 2014
Oral evidence, 1 July 2014.
Witnesses
Andrea Leadsom MP, Economic Secretary, HM Treasury, Alison Cottrell, Financial Services, HM Treasury, and Jeremy Pocklington, Director, Enterprise and Growth, HM Treasury, gave evidence.
Chair
Thank you very much, all three of you, for coming to give evidence this morning and thank you in particular to a former colleague of ours for coming. It is very good to see you again and it is always good news to discover that promotion is possible from this Committee into the ranks of Government. I felt that to describe it as a promotion would be the right thing to do but in time, Andrea, you are going to tell us whether you think it is indeed a promotion. Can I begin by asking you whether you have found that your enthusiasm for competition in financial services, which was very much in evidence when you were with us, has in any way been dampened now that you are in the Executive?
Andrea Leadsom
Thank you, Mr Chairman, for inviting me here today. The first thing I would like to say is I am very much missing the Select Committee. I am delighted to be back even though not in my usual place, which is now taken over by Mr Baker, very admirably. The second thing I wanted to say is that the four years on the Treasury Select Committee is the most astonishing preparation for ministerial office in the Treasury. The last thing I want to say is that on arriving in this role—where, as you know, I have been for just over two months—it is incredibly impressive to see the influence that the Treasury Committee and others have had on the way that thinking has developed in the Treasury. My early observation is that the system works, that the Treasury Committee does a fantastic job. If I can flatter you, without at all hinting that I might want you to be kind to me in the questioning, then I will do so. But specifically in answer to your question, no, my enthusiasm for competition is stronger than ever. I certainly think that the influence of this Committee on the competition agenda has been felt. There are a number of measures that the Government has taken—I am not sure to what extent they have been fully explained to the public as a whole—not only on competition but also on transparency to try and promote greater competition. These are two features of what I have seen on arriving in office. I am happy to expand on that if you would like me to.
Chair
Why don’t you say just a few more words on that since you have obviously given some thought to that point before you arrived?
Andrea Leadsom
Well, specifically on transparency, which is so important, as we know, we have 80% of all SME lending is done by the Big Four banks.[1] The Herfindahl Index of Concentration suggests that the BBA’s latest estimate is that SME lending is just over 2,000, which is extremely concentrated, versus other measures on, for example, credit cards at just the concentrated level. SME lending is a particular problem. Obviously we cannot suddenly magic a whole bunch of new challenger banks overnight, although good progress is being made. So what the Government has been doing is looking at measures to improve the data sharing. For example, in the Small Business Bill last week we have announced that credit histories will be required to be made available through credit ratings agencies so that challenger banks, with permission, will be able to look for new opportunities for lending. We are also consulting on requiring the big banks to make referrals. So where they do not make a loan, they will be required to refer to challenger banks to give them the opportunity. We have also got the postcode lending data, which requires the big banks to demonstrate by postcode where they are lending so that challengers can see where the gaps are. Another new initiative, which I launched just a couple of weeks ago, is the business banking insight, which is a quarterly survey of a random group of SMEs that will rate them according to service, availability of funding, terms and conditions in all different categories. So it is, if you like, an SME-led insight, which first of all enables banks to look at themselves and areas they can improve on but also for challengers to see what they could do, where the gaps are and so on. So all of those things are I think are really important in improving the competitive outlook.
Chair
Do you feel overall that the regulators have done enough to push forward the competition objectives that we gave them—for which you were a great enthusiast, and indeed instrumental—in getting further action on the statutory objectives of the PRA?
Andrea Leadsom
That is a really difficult question to answer. Regulation has been a bit of a moving feast, as we know, since 2010 where we completely changed all the regulation and things have moved on. As you have just heard, the Financial Ombudsman Service is now looking at whether it should go up the scale.
Chair
Why don’t I put the question slightly differently and in an easier form: are you able to give us a commitment you are going to help us hold their feet to the fire in making sure they do this and make it effective?
Andrea Leadsom
Absolutely. Yes, absolutely. I certainly think one area where there has been enormous improvement is in the provisional authorisations for new banks. I think we were all quite taken aback in 2010 when we discovered that Metro Bank was the first new full service banking licence in 100 years. Now the PRA is in talks with over 25 new banking applicants and they have had something like 47 pre-banking authorisation discussions. So that is a raft of difference, but, yes, I can certainly give you that assurance.
Chair
Someone in the Treasury is keeping an eye on making sure that another logjam doesn’t develop and making sure there are no Catch-22s in the system?
Andrea Leadsom
Absolutely, yes.
Chair
One last question before I pass the questioning on to Jesse Norman. There is quite a lot of unregulated lending, not by volume but by type, developing in the market. How much unregulated lending do you think we can accept?
Andrea Leadsom
There are particularly new diverse sources of finance such as peer-to-peer and crowd funding, and in those new markets—peer-to-peer we already know is being brought under a regulated environment and crowd funding is being considered for that and consulted on[2]—where new and completely diverse sources of funding are emerging it is important that we stay on top of it and have a close look at it and make sure that it does not become either a systemic or, indeed, a mis-selling risk. I think it is important that we stay on top of things as they change, however there is this fundamental principle that business lending itself is not regulated. It is provided normally by regulated entities but business loans themselves have not traditionally been regulated and I think according to the industry, there is not an appetite for general business lending to come under regulation. Do you want to add anything to that, Ms Cottrell?
Alison Cottrell
No, I think that is absolutely right and one of the balances we always have to strike is when we get the innovative sources of lending and other sources of funding developing, at a point you do get a demand from those firms for regulation. Generally that is because it helps them reputationally; it makes sure that everyone in the market is behaving well on a level playing field. But what we have to be very careful about and work very closely with the regulators on is to ensure that regulation when it is brought in is proportionate so that it does not just protect the incumbent and keep other new entrants out. That is what we have seen, as the Minister referred to there with respect to peer-to-peer and crowd funding.
Jesse Norman
I must say that last sentence is not what I would have expected a Treasury official to say. I am very pleased to hear you say that: proportionate; keep barriers to entry low, encourage the competition. That seems thoroughly good. Minister, may I say, we have gained a son but we also lost a daughter and we are very much missing her? May I also say how thrilled I am that your transition to the Treasury has not affected your trenchancy of language at all? The Committee, as you can appreciate more than anyone, enjoys crisp answers.
Chair
And questions.
Jesse Norman
Thank you for that, Chairman. I look forward to your interventions on my questions. Minister, I take it that you still think competition in this area is pretty inadequate.
Andrea Leadsom
Absolutely, yes. In the area of SME lending, absolutely, yes. There are improvements but there is a long way to go.
Jesse Norman
Would you also share my view that competition is not antithetical to safety; that competition and safety sometimes go together because you have, as it were, a more spread-out, more resilient market and not quite as—
Andrea Leadsom
Yes, and I would add a third, which is transparency. I think if everyone knows what is going on, they know what is on offer, they know when they are being given a bad deal and they know where they can get a good deal, that also keeps things safe and is as good as regulation in many ways.
Jesse Norman
So the model we evolved was an oligopoly banking system that was supposed to be safe but turned out to be not at all safe?
Andrea Leadsom
I completely agree.
Jesse Norman
Also rather poor on service.
Andrea Leadsom
Absolutely.
Jesse Norman
Thank you. Obviously it is a source of great concern to this Committee that SME lending has been so subdued. How would you value the Bank of England’s performance on that? Obviously they have ultimate responsibility for the regulation of the system.
Andrea Leadsom
Following the financial crisis and the regulative changes, the new capital requirements and so on, it was completely inevitable that banks could not be in a position to just carry on lending as if nothing had happened. Equally, of course, as we know, there is a huge raft of SMEs—something like 80% of SMEs—who are not borrowing for whatever reason. So SME lending has been very poor on a net basis—on a gross basis it has been growing, on a net basis reducing—ever since 2008, 2009 and that is a function of a huge number of things. I do not think it would be right to say that it is simply that the banks have not made finance available. Equally there is a question to be asked about why SMEs are not borrowing and that has, I presume, quite a bit to do with confidence in the economy and so on.
Jesse Norman
I should also ask the question whether you think the Bank of England was very slow to pick up the issue of SME lending and to try to think about how it could support that or boost it?
Andrea Leadsom
Yes. I think as we all recall at the time we were urging the Bank of England to look at SME lending and they were saying it was not in their remit to pick sectors. So the Funding for Lending scheme came in as a Government solution to facilitate the finance being made available to the banks and the carrot was, the more you lend to SMEs the more funding you will get. In other words, what the Government were trying to do was to facilitate that lending but the Bank of England, I think, still remains adamant that they are not there to pick sectors.
Jesse Norman
But the point where the Bank did start to accept that it was responsible in the SME area and was specifically trying to target small and medium-sized enterprises, that has been pretty slow and pretty ineffective, hasn’t it?
Andrea Leadsom
It has been slow. The Funding for Lending Scheme has been rather successful, there is evidence—
Jesse Norman
No, but in the SME sector particularly.
Andrea Leadsom
No. The FSB has said that they believe that the Funding for Lending Scheme has kept costs of lending to small businesses down, and there is evidence that gross lending has grown. I would agree with you that the Bank of England was slow, but subsequent to that we have had a massive shock to the system and banks are still trying to sort out their balance sheet. So there have been all sorts of headwinds against an improvement in the lending environment that is not just about slow-to-act regulators.
Jesse Norman
Just to be clear, would you be comfortable with—obviously we heard from the FCA earlier—and would you support, a reduction in capital requirements; easier and more cost effective access to the Funding for Lending Scheme for these challenger banks?
Andrea Leadsom
I would not necessarily say I would go for smaller capital requirements. I think that is very rightly, properly, a regulatory issue that is about safe lending. But in terms of access to Funding for Lending, access to funding for challenger banks to be able to on lend to SMEs is absolutely critical, as is data sharing, referrals access and so on to enable them to access who wants to borrow.
Jesse Norman
Do you think the Government ought to consider a specific further scheme that is designed to support challenger banks in the process? You now have a raft starting to get going; you might be able to get five, ten, 15 of these banks to draw on specific funding arrangements that would allow them a more rapid entry into the market?
Andrea Leadsom
It is a very interesting idea but it is not clear to me that you would need a specifically challenger-bank targeted measure. As I tried to outline in my opening remarks, there is a huge raft of opportunities that are there specifically to support getting challenger banks to be able to identify where the potential demand is for loans, through postcodes, through credit referrals, through direct referrals and so on. Those kinds of measures are specifically targeted to support challenger banks. It is just not clear to me that they need some other specifically financial incentive. But it is worth considering.
Jesse Norman
But you might consider it if the other schemes were not panning out as quickly—
Andrea Leadsom
Yes, definitely worth considering.
Jesse Norman
—or if FLS gets withdrawn then you might consider that?
Andrea Leadsom
Definitely worth considering.
Chair
Very helpful and interesting exchanges. Mark Garnier.
Andrea Leadsom
Ms Cottrell has a comment to make.
Alison Cottrell
I think it is a very good point and, as the Minister says, we are always open to new ideas, but also as the Minister has said this is just one piece of the jigsaw. You have mentioned transparency, you have mentioned specific schemes but it is also about awareness among SMEs themselves of what the schemes are and what they are doing. What we are continually trying to do is raise awareness of these schemes. One of the latest SME finance surveys suggested that about 22% of SMEs who were borrowing or interested in borrowing thought that the FLS had made it more likely that they would go and try to do that borrowing. As with the FLS and with lots of other schemes, we need to make sure that SMEs know what is out there because part of the schemes is aiming at the lender and part of it is aiming at the confidence of the borrower. It is both of those things. We need the credit register, we need lots of other things, to bring all these pieces together.
Chair
I have done a straw poll at the local Chamber of Commerce and awareness, even among people you would expect to know, is we have a plethora of schemes—
Alison Cottrell
Absolutely, which is also where the business bank may be able to help.
Mark Garnier
Can I add my congratulations on your moving sideways from the Treasury Committee to the Treasury itself? Promotion. Can I just carry on with one point of Mr Norman’s? This is some sort of funding for challenger banks. The British Bankers’ Association—and I know one or two other people have also mentioned this—have said one of the problems that a challenger bank has is that they can’t compete on the same basis in terms of their funding costs so the bigger banks, where there is still this implicit guarantee, fund cheaper than the smaller banks can do. One or two people have suggested that some sort of system whereby the smaller banks could have available funding at the same price as the bigger banks would be very helpful for competition. Do you agree that would help or do you think it is a bit of a red herring?
Andrea Leadsom
No, I certainly do not think it is a red herring. I guess I am simply saying that it is not clear at the moment that the evidence is that challenger banks are failing to lend to SMEs on the grounds of their funding cost. It seems to me that the issues are more structural around knowledge. If I am a sole trader and I never heard of—take Handelsbanken, for example—I have never heard of them and I will not think to go and ask them for money. So it is those issues as opposed to when I do find them they then cannot afford to lend to me. I absolutely take that on board and will go away and think about it.
Mark Garnier
One of the issues that slightly perplexed me about bringing more competition into the banking market has been that where you tend to get a lot of competition among banks is in aiming for that very simple type of loan where you have a decent asset, maybe a factory or something, backing a loan. It is the other area of the SME market that is proving to be much more of a problem for banks, so where you have something slightly more esoteric, like the property rights on a game where you wanted to borrow money in order to try to market that. How do you see competition in the banking market being able to direct itself at that much more complex area of the SME lending rather than the traditional area?
Andrea Leadsom
Again, this is an argument for competition and diversity. For example the asset-leasing organisations are doing a dramatic increase in their loans to businesses, some phenomenal sum, some 13% increase in asset-backed financing and leasing financing. There are specialist organisations that are looking at more complex areas of business lending and, of course, more competition will lead to different expertise in different areas. One quite interesting initiative: Santander has just set up an arrangement with the Funding Circle, which is a peer-to-peer group, where they will mutually refer to each other. So if Santander turns someone down because of complexity or because it does not meet their credit scoring targets or whatever, they will refer it to the Funding Circle, which may have individuals who have a bit of spare cash who would be interested in that loan. All that competition diversity is intended to promote a diverse range of availability of types of finance as well as just different lenders.
Mark Garnier
Are you happy that the diversity element of that is working as well as you would have hoped?
Andrea Leadsom
No, I don’t think it is. We are still at an early stage. The continual net reduction in lending to SMEs is very regrettable and the day that net lending is up will be a day for celebration. But, equally, that has to do with confidence in the economy; it has to do with businesses wanting to borrow and whether they want to just borrow a straightforward term loan or a short-term loan or an overdraft or asset-based financing. That is all a function of supply and demand. We need the economy to be growing as it is and we need lots more competition and diversity. We are getting there. We are all heading in the right direction but there is a long way to go still.
Mark Garnier
Any significant barriers to entry, to diversity, that you can think of?
Andrea Leadsom
No. I think the Chairman’s point about regulation of new sources of funding is important, that the regulators stay on top of any new emerging area that could become problematic. But otherwise, what the Government wants to do is to encourage more innovation. Just literally a couple of weeks ago I was speaking at the 50th anniversary of the Credit Union Movement— a very longstanding group of organisations but doing a fantastic job, and a diverse source of funding—which encourages people to save as well as to borrow. So encouraging those diverse types of organisations as well is very important in the overall mix.
Mark Garnier
My final question, if I may, Chairman? There is a lot of talk about regional banks, local banks and that kind of stuff: do you think this is something where the regulator should try to create legislative space in order for regional banks to develop? Or do you think this is something that the market should try and develop in its own way as part of that general mix of new types of banks coming into the place?
Andrea Leadsom
As you know, Mr Garnier, I am a big believer in the free market’s making its decision. We are already seeing that regional banking is becoming more attractive. We are seeing some of the existing players basing themselves in the regions, like Virgin Money, TSB with their new IPO and so on. That is to be encouraged and facilitated rather than state or regulatory engineered.
Mark Garnier
Fantastic, thank you very much.
Mr McFadden
Minister—
Chair
You will have to put up with this, I am afraid for another couple of hours.
Andrea Leadsom
Yes, I know, I know. I am trying not to take it as an insult.
Mr McFadden
Welcome back. Some of this is not for Government—some of it is for banks or for lenders and so on or maybe for regulators—but there is a part of this that really is affected by Government, which is the tax treatment of different forms of finance. There has been a long debate about the different tax treatment of debt and equity. The Banking Commission looked at this quite a lot. I do not think it is a secret to say that the former Chancellor, Lord Lawson, was particularly interested in this area when we did the Banking Commission’s work. Can you tell us anything about the Treasury’s thinking on this debate because the argument is that the traditional model of financing business through debt is encouraged by the way that these things are taxed?
Andrea Leadsom
Yes, I am very aware of that argument and I am slightly cautious because this treads very firmly into the Exchequer Secretary’s portfolio and it is not something that I am very up to speed on where the Government’s thinking is. I share your interest in the unintended consequences of the favourable treatment of debt over equity from a tax perspective, but at the same time I do very firmly believe that the mix of the actions taken by the Government, by the banks themselves, by the international regulation is changing in itself the incentives vis-à-vis equity and debt. It is encouraging much more capital. We are looking, as you know, at bail-inable bonds and we are looking at different means of achieving greater safety in the banking system. So I think that the tax system will in due course be another way of looking at this but I don’t have any specific pointers to give that we are looking at something very specific. I don’t know if Ms Cottrell wants to add anything to that or Mr Pocklington? No?
Mr McFadden
Officials must have had a run around the course on this. Would neither of you like to elaborate?
Jeremy Pocklington
This is an issue that has come up time and again over decades. There are arguments for it. There are arguments against it; against equalising the treatment. One of the great challenges is how would you transition from a world where you have debt having a favourable tax treatment to a world where it does not. That would create all sorts of challenges. It is an issue that periodically comes up.
Mr McFadden
Let me ask you this from a different angle then. Do you think that the debate about this might be given greater urgency by the parallel but related debate over the weaknesses of the corporation tax model as it stands at the moment whereby multinationals in particular appear to be able to shift things around? Your boss, the Chancellor, has made a big issue of this at G8 meetings and so on. If corporation tax is a tax on profits, which seems to have weaknesses in term of people being able to avoid it, might looking at debt and equity be given greater urgency by that debate?
Andrea Leadsom
I am struggling to see why by focusing on equity you would change the issue—
Mr McFadden
Well, if you have a lot of debt payments every year it will reduce your headline corporate.
Andrea Leadsom
Yes, but that is not affected by the onshore, offshore point that you are making about companies booking profits elsewhere in a lower tax regime. I do take the point that debt is offsetable against tax and it is definitely something that the Government looks at from time to time but not in my department. I am very wary of straying into that.
Mr McFadden
Okay, I think I will stop there.
Mr Mudie
Welcome, Minister. The Treasury’s gain is our loss. You are very much in favour of competition—this is one answer I will not like—and I think that is a good thing but why do we only have one regulator? When you see their performance this morning, “It is not in my remit”: people are being hurt, it is in their field but they have some narrow point that they seem pleased it is not in their remit. It takes you back to Lord King when the crisis broke. “Nothing to do with me, it is the FSA.” We were in the States and you would not have this situation arise in the States because if one regulator does not go in, the state does not go in, the Fed goes in or the Attorney General goes in. There is nowhere to hide in the States but here you have a very cosy, happy—the Ombudsman, “I don’t want any more powers”. Don’t you think we could do with more competition?
Andrea Leadsom
I am not sure—
Mr Mudie
I knew you would say no but it is worth thinking about.
Andrea Leadsom
Yes, I know Mr Baker will be delighted with that idea. In principle, I think that competition in regulation, as in all areas, is advantageous in the sense of then you do get regulators falling over each other to take up an issue. The downside of course is lack of certainty to the industry. In your previous hearing, one of the very interesting things that came up was the gentleman from FOS who was saying that unlike in lots of other retail sectors, banking appears to require a lot of regulation and punishment in order to make them behave at least normally. The issue that we have in the UK is around a culture that got out of hand and is now righting itself. Competition in the delivery of service is absolutely vital. I think where regulation is concerned you need certainty of regulation; you need fairness and you do need perimeters. I noted Lord Thurso’s points about the definition of sophistication and completely accept, as he say, that the beauty is in the eyes of the beholder. Sophisticated is what you make of it. There are always going to be grey areas. I would also agree with you that there must be times where the regulator should say, “Well, okay, it is not technically our area but we are going to comment anyway” and I completely accept that that would be a legitimate thing for them to do. But my underlying thesis here is that we live in a western democratic capitalist society where we need wealth generation in order to pay for the public services we all want. So what we cannot do is to regulate things to the point where they can no longer be profitable and successful organisations. There is always going to be a fine balance. That is probably not the answer you want to hear but I would not therefore advocate pure competition in regulation. The other thing I would say is that with the tripartite system the problem was a lack of accountability. While you are saying there is now a lack of accountability because they will not go outside their remit, at least there is accountability in that there are not three different people looking at bank regulation, new bank approvals, market misconduct and so on. In that sense each of those regulators is entirely accountable for their area and that is a very good thing.
Mr Mudie
That was what the problem was or seemed to be when the recession came, that the FSA said, “This is our remit”, the banks said, “This is our remit” and there was stuff in the middle that they were content to just let go because, “It was nothing to do with me, Guv”.
Andrea Leadsom
Exactly.
Mr Mudie
You have obviously read the evidence we have received, by the sound of it, or you have read some of it. I have said some stuff today that I can read you, but can you defend the regulators not being willing to accept there was a grave problem that was affecting a vital part of the economy because it was not in their remit?
Andrea Leadsom
Can you just expand on exactly what that part of the economy was?
Mr Mudie
The small businesses.
Andrea Leadsom
So the small business lending? Why they did not intervene more to, what? To force banks to lend to SMEs?
Mr Mudie
Well, no. I plead with you to get Berg in and Bully-Banks and sit with your officials and go through and question them. We have not had the opportunity to question Berg. I could go through a whole list of what they do and why they do it. They are doing it to get their hands on the capital that is involved in there. They do some dreadful, dreadful things. Let me just give you an example, when John McFall was here in the last Administration we took on consumer rights and we had a real battle over the five or so years with the banks but we got somewhere. What is crying out now is for someone to look after small businesses’ rights because they can do it so easily: a drive-past valuation on your property; call you in; loan-to-value; it’s out. If you consider a mortgage that goes through in a recession and goes into negative equity, you would string up a bank if they called the mortgage in because it was loan-to-value deficient, but they do it for small businesses. They finish them off or they bring them in, they change all the terms, they put them into this corner of the bank, that corner of the bank, all paying fees and they have done that. Berg’s report on their experiences and their cases say it is not limited to RBS. Barclays, HSBC, Lloyds, they are all at it, destroying viable businesses because they want to get their hands on capital.
Andrea Leadsom
Yes. From my own experience, I have a lot of businesses obviously in my constituency near Silverstone and we have lots of high-tech performance engineering businesses. I have had some of my businesses say to me that it is not so much the availability of funding or the assessment as what happens once you have the loan and they appear to just help themselves and charge you these huge renewal fees and so on. I have taken up a lot of these issues and certainly I do have a residual concern about the way that banks handle internally the complaints procedures. Just in my couple of months in the job I have answered a lot of correspondence from colleagues who have individual grievances from businesses. Obviously no one is ever going to legislate to say, “You, bank, have to lend to this trader because ultimately if the loan goes bad then it’s my fault because I made you lend to them”. We cannot obviously do anything about that but what we can do is look more carefully at how the banks manage those complaints procedures. Certainly as an MP myself, I have had issues with that. I know I have heard colleagues on the Treasury Committee talk about that too. I do think that that is an area we could look at. Having said all of that, you see, that is within the regulator’s remit. It is not true to say that they cannot look at banks internal complaints procedures because they regulate the banks. I would just simply disagree that the regulator can say, “That’s not our problem” because I think that that is within their remit to do that.
Mr Mudie
That is very fair but if we were to list in the evidence in our report all the areas where evidence has been given that the banks have behaved badly—and I could list them for you here, I have one of the reports here—would you be willing to look at it and have your officials run down those and tick off those that can and should be dealt with the regulator and ask the regulator why they are not doing it? And secondly, for those that are not ticked off, take an urgent look at legislation?
Andrea Leadsom
Certainly, if there are specific examples that you wanted my department to look at we would certainly do that. I would not predict the result of it but certainly would be very happy to look at them.
Mr Mudie
No, but, Minister, you did say that you thought that there were areas where they could be looking at it, were able to within their perimeter. If we listed areas where evidence has been given to us and your officials say, “They can do it” then I presume the Treasury would be willing to ask the FCA formally why on earth they are not taking action or have not taken action. But those areas where your officials say, “They are right, they do not have the power” surely the Treasury—not you and I understand the position I may be putting you in—should be looking to see— Last week we had the Governor of the Bank of England in and I asked him about exports and about rebalancing the economy and he was all over the place. Small businesses are failing; exports are failing; the sector is not growing or not growing as fast as you would wish. This is supposed to be rebalancing but here is a vital part of that rebalancing being sabotaged by banks. Surely they cannot get away with this.
Andrea Leadsom
Yes. I will happily look at anything you want to send me, Mr Mudie, and go it through it very carefully. But, as I said at the start, I am an absolute believer in free enterprise and there is a lot going on in the SME world, including SMEs thinking, “I don’t want to export at the moment because the economy doesn’t look good enough to me”. There are all sorts of reasons. It is very difficult to pin down exactly why things do not happen. In answer to your specific question, if you wanted to send me some examples—
Mr Mudie
The Committee have put it in their report.
Andrea Leadsom
If the Committee wanted to send me some examples and there were cases that the regulator should be, could be, looking at, then of course the Treasury would certainly pass them on.
Chair
The consumer interest is right at the heart of what Mr Mudie is trying to achieve and has been for years.
Andrea Leadsom
Exactly, yes, yes.
Chair
Of course, we did the cheques inquiry where the banks, on a quiet day, it seemed were intending, effectively, to withdraw cheques. We find all sorts of similar practices going on in the SME market as part of this inquiry. All I will say with respect to that is we are intending to report as a Committee. I do not know what we are going to report but it will be useful having you in the Treasury to take a look at it when we do.
John Thurso
Minister, I am enjoying the delicious irony of the fact that you and I persuaded the Committee to kick this report off and you are now answering for the Government on the other side. May I say that, as a former gamekeeper, you make an excellent poacher?
Andrea Leadsom
I am hoping I am consistent; internally consistent is my aim.
John Thurso
On the TBL side I want to ask you, as I am sure you were expecting, why has the Treasury so far refused to engage on that issue or have anything to do with it?
Andrea Leadsom
I am not aware that the Treasury has refused to engage in the issue. The point is that there will not be retrospective legislation on issues beyond those that are the sale of regulated products that have been mis-sold. The interest-rate hedging products, where they have been found to be mis-sold and they are, therefore, regulated by the FCA, are part of that inquiry. I know that the Committee has been impatient with the slowness of their kick-off but I hope the Committee is now happy that things have speeded up, a lot of customer redress has been made and the process is now well underway and drawing some conclusions.
John Thurso
When did the Treasury first become aware of the TBL problem?
Andrea Leadsom
Ms Cottrell, can you—
Alison Cottrell
I do not know precisely. You have mentioned the letter that Martin Wheatley wrote to the then FST, Greg Clark, and certainly that focused on that area. I cannot tell you if it was before that or if that was there but it would be around that time.
John Thurso
What response has the Treasury made to Martin Wheatley? What have they written in response to his letters and concerns?
Alison Cottrell
I am not aware—and this is just from memory—if we replied to Martin’s letter as such. Certainly, he would have had frequent meetings with the then FST, so it would have been discussed there in the context of TBL.
John Thurso
The FCA had raised what they considered to be a pretty big problem, which the Treasury initially was not going to release under freedom of information, but this Committee got that correspondence and here we are a year and a half on and there is no response. I would suggest to you that that does not show a particular willingness on the part of the Treasury to engage or deal with what an awful lot of people think is a pretty serious issue.
Alison Cottrell
The specific issue of the NAB loans, as you know, was brought voluntarily into the FCA scheme, which was the issue that, as far as I am aware, Martin was talking with the then FST about.
John Thurso
The point that Martin Wheatley was making in his letter was that it appeared that these products were not regulated and, therefore, they did not have jurisdiction. The first question: do you buy into that legal advice because there is opposing legal advice that has been given by eminent counsel that says it is regulated?
Alison Cottrell
I would accept the FCA—
John Thurso
Has the Treasury got its own legal advice on that? Does the Treasury share the point of view that this is not regulated?
Alison Cottrell
Yes.
John Thurso
Does the Treasury believe it should be regulated?
Alison Cottrell
That would be a question for Ministers if they wish to change it but at the moment, in terms of the scope, it does not come into the FCA scope.
John Thurso
In other words, is this an accident that it is not regulated or is it on purpose?
Andrea Leadsom
My understanding is that the business-lending element of those TBLs is not regulated and that there is no appetite from the industry—
John Thurso
Forgive me, Minister; that is not the point.
Andrea Leadsom
Yes.
John Thurso
The point is that in all the evidence we have received a TBL looks like a duck, quacks like a duck, paddles like a duck and, therefore, for our purposes it is a duck.
Andrea Leadsom
Yes.
John Thurso
The fact that there is a technical difference, that the way that the contracts for difference is written may exclude it from being under the auspices of the FCA, is one that has only just come to light or more recently come to light. Most of us would have thought it was regulated. The question, therefore, is this: I know the historic position as it is seen; is that intentional or unintentional?
Andrea Leadsom
My problem is not knowing the historic intention. What I can say is that business lending should not in my opinion fall under regulation. Interest-rate hedging products should fall under legislation and the extent to which you combine one with the other—and it walks like a duck and quacks like a duck—then I would say you should not combine them. You should sell them separately or—as is, I understand it, now the case—you should make extremely clear in words of one syllable exactly what the implications are if you repay that loan early.
John Thurso
Can I help you? My understanding is that this is an entirely unintended consequence—that nobody thought this product particularly existed—and having discovered the fact that it is not regulated is something of a complete accident. Martin Wheatley, in the meeting I referred to with him with Chris Woolard last week, said they would very much like to regulate this. Their position is they think it should be regulated and they would like to regulate it. Chris, on the record, did not quite give the same but he came very close, given that it was evidence.
Andrea Leadsom
Yes.
John Thurso
You can talk to Martin Wheatley and I think you will find that they would be very keen to see this properly regulated. At the very least, going forward, could we not get this situation resolved so it is clear, that if you do something that ought to be regulated, it will be regulated?
Andrea Leadsom
I am obviously not making myself clear. I think that a business loan should not be regulated.
John Thurso
I am happy with that.
Andrea Leadsom
But if you turn it into a term business loan by fixing the interest rate then the only way to make the product itself—so the tailored business loan or whatever you want to call it—regulatable is by splitting out the swap from the loan. What you would be doing then is you would be saying that the small business who wants a three-month, six-month loan has to have a short-term loan with a three- or six-month interest-rate swap attached in order that the interest-rate swap becomes regulated. Then the question is, is that complicating things extraordinarily, both for the bank—because it is having to individually hedge every single loan it makes—and for the customer, very importantly, because they’re like, “I don’t know if I want to buy an interest-rate swap. What on earth is that?” That, I think, is the problem. I was talking to officials about this last night. Unless you were to stray into the territory of saying there are certain types of business loan that will in future be regulated—which, as I understand it, consultation with the industry suggests that the industry trade bodies do not want—
John Thurso
Nobody is arguing that. Nobody wants to regulate loans; that is not the point. The point is the contracts and we have the contracts and can I refer you to the evidence that Laurence Beere, among others, gave us and your officials, I am sure, could do so too. The fact is you have a contract that lays off the entire risk of the swap that the bank has taken to book out their position. That entire consequence, the loss of that, is placed into the loan by way of the contractual paragraphs in the loan relating to the fixed element. The problem is that it is not six months and £20,000; it is £750,000,000 and 10 years and that is where we have the difficulty. There are two things. People have been sold a product that they are told is a fixed-rate loan and, as you and I know, there is no such thing. What they do not know and do not understand is the fine print and it is not explained to them. That, to me, should be regulated. The FCA thinks it should be regulated. The law appears not to regulate it. Will we do something about it?
Andrea Leadsom
Just to come back once more on a point of clarity because, of course, what happens is if a bank is making, say, 20 £500,000 loans for six months then it may well aggregate the sum that it has lent out and hedge the entire lot on its book.
John Thurso
It may be an aggregated swap.
Andrea Leadsom
It may be that because it has already got other swaps on its books—
John Thurso
But it is what is in the contract that counts.
Andrea Leadsom
—that it in fact does not hedge it at all because it is already over-hedged so it may simply allay an overly-hedged position on their book. So my question for you is, how would you split out the consequences for the bank’s book? Obviously banks might sort out to perfection their hedge once a week; they might not do it on a loan-by-loan basis or even an hourly or even a daily basis. So how would you allocate? In terms of regulation what are you regulating, their entire swaps book or the piece of it that relates to that loan and how do they know which piece that is?
John Thurso
If I may, Minister, you miss the point. I am completely uninterested in what the banks do. What I am interested in is the impact on the consumer and that can be found in the contract between the bank and the consumer. The kick-in is whether or not the negative or positive impacts are felt by the consumer. In other words, does the bank lay off its risk in the contract so the consumer pays the break cost or not? That is all that you need as a definition.
Andrea Leadsom
Effectively, what you are looking for is for the FCA to regulate the breakage costs of a term loan.
John Thurso
No, that is oversimplifying it. It is where a loan is given such that it is not a simple fixed interest rate and there is a series of clauses in the contract that tie it to whatever swapping mechanism is behind it and, therefore, the small business ends up unaware—because it has been mis-sold and he doesn’t understand this—of the consequences and suffers loss as a result. That is the core of the issue. I will happily come and see you. It might be easier to talk about it separately.
Andrea Leadsom
Yes, this is kind of a several-cups-of-coffee because—
John Thurso
Maybe I can come and meet with you on that because I want to quickly move on.
Andrea Leadsom
Yes, yes, okay.
John Thurso
The key point here is the FCA told me privately—and Chris said quite clearly when he was here—that they are, far from being averse to regulating: yes, they believe it should be regulated properly and it is up for us in Parliament to give them that. The second thing was on the FOS and I know you have heard the evidence. Broadly my reading—and this is a terrible paraphrase of a lot of evidence but I am forced by time to do it—is a view that for small businesses do we need to look at both the scale at which they can intervene and the size of the award they can make. It seems we are all agreed on that. My question is this. Do you accept that and what will Government do about it?
Andrea Leadsom
Right, as I understand it FOS are consulting now[3] and will be reporting on that by the end of this year. Is that not right, Ms Cottrell? Yes.
Alison Cottrell
Yes, the FCA will have a review in the autumn.
John Thurso
How will Government give effect to either of the propositions I am putting forward, which are FCA regulation or FOS?
Andrea Leadsom
To FOS increasing their remit and scale of business, is that secondary or primary legislation?
Alison Cottrell
I don’t know but certainly in relation to the point, if the FCA were to come and say, “This is the way we would recommend we go forward with FOS” then we would certainly consider that.
John Thurso
Can I come in to you with a possibility? It is that number one in the Queen’s speech is a Small Business, Enterprise and Employment Bill, the purpose of which—which I suspect will be the long title—is, “To build a stronger economy by supporting small businesses as they compete and show that they are not disadvantaged by those that do not play by the rules”—sounds good—and that the main elements of the Bill are two and that the first bullet point says, “Make it easier for small businesses to access finance”. That would be an excellent vehicle to deal with all of those things and we can do it in short order.
Andrea Leadsom
In very short order, I completely agree with you.
John Thurso
On which happy note I conclude. Thank you, Minister.
Andrea Leadsom
Thank you.
Mr Mudie
I hate to be in a minority of one but I feel I am in terms of the phrase everybody is against regulating commercial lending. I do not think that I am in the place or you are in the place or anyone in this building is in the place where we can tell banks who to lend to. They take the commercial decision. But once they have taken a commercial decision the contract they enter into with the individual should be clear, should not be mis-sold, and the consequences of actions all throughout that contract must be understood by the borrower. What is happening now—and we get waylaid by the technical problem of swaps—to property companies, hoteliers and so on, is that the banks just decide. There is a case in one of the papers where the fellow didn’t pay his paper bill for two weeks. The bank heard about it and used that as the opportunity to tear up the contract and renegotiate. There was a case where somebody goes in—and you can imagine it, Minister—they get a £1 million loan, right, and in the contract and in six months’ time they will get a second £1 million. So they go and they spend the money and then the bank blithely turns round and say, “No, we’re not giving you the second £1 million”. I refuse to believe that we would allow that to happen to a consumer. The bank is in the strong position, it can negotiate the terms, it does negotiate the terms, the person agrees the terms. Then the bank unilaterally changes its terms within the term of a loan without good reason. That is where we are pleading for the regulators to come in, as they would with any other contract, to defend the weaker party. Does that not stir you to start questioning? It is not the actual lending, it is once you have lent and you are the bank. You know the consequences; you have all the experts; you sign that contract only with good reason and in line with the contract: should you be able to alter that contract?
Andrea Leadsom
Yes. In terms of your example I completely agree with you. Banks absolutely should not be just moving the goal posts, all things being equal.
Mr Mudie
They are doing that.
Andrea Leadsom
It is absolutely right that they are regulated by the regulators who are there and supposed to ensure that they treat their customers fairly, that they have a properly instituted complaints procedure.
Mr Mudie
Yes, that is all we are asking for.
Andrea Leadsom
On that I completely agree with you.
Mr Mudie
But these characters who were here before you say, “The fact that it is commercial lending, we don’t regulate that”. They turn their backs on what is happening to good citizens who are trying to earn a living and say, “We don’t do it”. We are not interfering with the banks’ right to lend. It is that the contract they enter into must be fair, honest and clear.
Andrea Leadsom
What I heard them say is that they would look at trends; that they would not look at an individual case. They would look to see that a bank was properly implementing its own complaints procedure and that there weren’t systematic failures to treat customers fairly. That is certainly what I heard them say, which is right. It is very difficult for any one of us to say, “That was unfair treatment and that was not deserved”. But at an aggregate level it is entirely right that those banks are regulated entities. They should have systems. There should be the means by which to appeal where they are not being fairly treated. But then, equally, there is another side of this argument, which is that for those bigger businesses we do not want to just be a nanny state and make them not suffer the consequences of their own decisions either. To interfere in the commercial arrangements is a mistake but the regulators absolutely need to ensure that they have proper complaints procedures and that they implement them fairly.
Chair
My colleagues are reluctant to let you go. John Thurso has got a rejoinder
Andrea Leadsom
Okay.
John Thurso
Just one point. I do not ask you to answer but following on from what George said, nobody is asking the Government or anybody else to regulate a simple loan product. We are asking for the regulation of the conduct of the people engaged in the selling and managing of it. That is where we agree. Nobody wants to regulate lending per se but lending that is sold inappropriately. The problem is that if you ask the FCA, their definition of what they can regulate is based on whether it is a regulated product. That is the lacuna at the moment, if I may leave you with that thought.
Andrea Leadsom
Yes, that is a very interesting point. Yes, thank you, definitely.
Chair
You can hear the frustration, Minister, coming out of a good number of colleagues. I have seen some of these cases in my constituency and some of them are very bad and something needs to be done. We shall be reporting in due course and no doubt then we will have exchanges of which we should consider this one to be the first of many. It may be more awkward next time when we have firm recommendations on the table. But in the meantime, welcome to your new job. You have given lucid answers, just as you always asked lucid questions, and we are very grateful to you for your evidence, what is now this afternoon.
Andrea Leadsom
Thank you. Oral evidence: SME Lending, HC 204 47 [1] Note by witness: meant to say ‘80% of SME’s main banking relationship is with one of the big four banks’ [2] Note by witness: meant to say that ‘the FCA has recently published details of its approach to regulating crowd funding’ [3]Note by witness: meant to say ‘the FCA will be consulting’