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EE/S3/10/R3

3rd Report, 2010 (Session 3)

Report on the way forward for Scotland's banking, building society and financial services sector

Volume II – Full Report

Remit and membership

Remit:

To consider and report on the Scottish economy, enterprise, energy, tourism and all other matters falling within the responsibility of the Cabinet Secretary for Finance and Sustainable Growth apart from those covered by the remits of the Transport, Infrastructure and Climate Change and the Local Government and Communities Committees.

Membership:

Ms Wendy Alexander
Gavin Brown
Rob Gibson (Deputy Convener)
Christopher Harvie
Marilyn Livingstone
Lewis Macdonald
Stuart McMillan
Iain Smith (Convener)

Committee Clerking Team:

Clerk to the Committee
Stephen Imrie

Senior Assistant Clerk
Katy Orr

Assistant Clerk
Gail Grant

Report on the way forward for Scotland's banking, building society and financial services sector

Volume II – Full Report

The Committee reports to the Parliament as follows—

INTRODUCTION

1. This inquiry report is the culmination of over six months’ work. The Committee would like to thank its adviser, Philip Augar, whose guidance, knowledge and expertise helped to focus the inquiry and shape the report. His advice has been extremely valuable. The views, conclusions and recommendations expressed in this report, however, are those of the Committee and may not necessarily represent those of our adviser.

2. The Committee would like to thank all of those individuals and organisations that either submitted written evidence or gave oral evidence during the inquiry. Their views and expertise were important, both in terms of providing information of relevance to the inquiry and in informing our conclusions and recommendations.

3. The Committee would also like to thank Mervyn King, the Governor of the Bank of England; Lord Turner, the Chair of the Financial Services Authority; members of the Treasury Select Committee and the Commission on the Future of Banking, all of whom took the time to meet the Committee and discuss the financial crisis and the Committee’s inquiry during a visit to London.

4. Finally, the Committee would also like to thank the Scottish Affairs Committee for sending a copy of its report on Banking in Scotland1 and the Chairman of the Committee for meeting our Convener on a visit to Scotland and for the useful discussions that took place.

Evidence

5. The Committee received over forty written submissions in response to its call for evidence on the inquiry. During the inquiry the Committee heard evidence from the following witnesses:

16 September, 2009

Paul Chisnall, Executive Director, British Bankers' Association;

Adrian Coles, Director-General, The Building Societies Association;

Owen Kelly, Chief Executive, Scottish Financial Enterprise.

23 September, 2009

Dr Andrew Goudie, Chief Economic Adviser, Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, and Margaret M McGrath, Financial Services Team Leader, Scottish Government.

30 September, 2009

Robert Peston, BBC Business Editor, BBC.

4 November, 2009

Clive Maxwell, Senior Director, Services, and Alistair Mordaunt, Director, Mergers, Office of Fair Trading.

11 November, 2009

Jeremy Peat, Director, David Hume Institute;

Tony Prestedge, Group Development Director, Alison Robb, Divisional Director, Group Strategy & Planning, and Rudolf Heaf, Interim Managing Director at Dunfermline Building Society, Nationwide Building Society.

18 November

Irmfried Schwimann, Director for Markets and Cases III - Financial Services, DG Competition, European Commission;

Michael Kirkwood, Board Member, Sam Woods, Chief Operating Officer, and John Compton, Head of Market Investments, UK Financial Investments Ltd.

25 November, 2009

Stephen Hester, Group Chief Executive, and Andrew McLaughlin, Group Chief Economist, The Royal Bank of Scotland Group;

Gillian Tett, Assistant Editor of the Financial Times, in charge of global markets.

2 December, 2009

Archie G. Kane, Group Executive Director, Insurance and Scotland, Lloyds Banking Group.

9 December, 2009

John Rendall, CEO Scotland, HSBC;

Jon Pain, Managing Director Supervision, Financial Services Authority.

16 December, 2009

Benny Higgins, Chief Executive Officer, Tesco Bank;

David Thorburn, Executive Director and Chief Operating Officer, Clydesdale Bank.

6 January, 2010

Rt. Hon John McFall MP, Chairman, House of Commons Treasury Committee, and Eve Samson, Clerk of the Treasury Committee, House of Commons.

13 January, 2010

David Nish, Group Chief Executive, Standard Life;

Maggie Craig, Acting Director General, Association of British Insurers.

20 January, 2010

Steve Smit, Head of State Street Investor Services UKMEA and Global Markets EMEA.

27 January, 2010

Bryan Johnston, Divisional Director, Brewin Dolphin;

Stephen Boyd, Assistant Secretary, Scottish Trades Union Congress;

Wendy Dunsmore, National Secretary, and Rob MacGregor, National (UK) Officer for Finance, Unite the Union;

Colin Borland, Public Affairs Manager, Federation of Small Businesses, and Brian Scott, Assistant National Secretary, Unite the Union, representing the Post Bank Coalition.

3 February, 2010

Angus Tulloch, and Stuart Paul, Investment Managers;

Richard Martin, Head of Financial Reporting, The Association of Chartered Certified Accountants;

Bruce Cartwright, Chairman, Technical Policy Board, The Institute of Chartered Accountants of Scotland, Partner & Head of Recovery Services PricewaterhouseCoopers;

David Wood, Executive Director, Technical Policy, The Institute of Chartered Accountants of Scotland;

Iain Coke, Head of Financial Services Faculty, Institute of Chartered Accountants in England and Wales;

Richard J. Hunter, Group Managing Director for Corporate Ratings Europe, Middle East, Africa and Asia, Fitch Ratings.

10 February, 2010

Jim Watson, Chairman, and Gordon McGuinness, Member, Financial Sector Jobs Task Force;

Mark Tennant, Industry Deputy Chair, Financial Services Advisory Board;

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth, David Wilson, Director of Enterprise, Energy and Tourism, and Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, Scottish Government.

24 February, 2010

Willie Watt, Chief Executive, Martin Currie Investments Management Ltd.

The remit of the inquiry

6. As part of the inquiry, the Committee sought evidence on the following issues—

  • What is your view on the cause, nature and impact of the recent difficulties in the financial sector in Scotland?
  • What evidence do you have on the issue of the availability and the cost of credit and what effect have the initiatives undertaken by the banks, government bodies, regulators and others had?
  • What changes can be expected as part of the ongoing and future restructuring plans in the financial services sector within Scotland?
  • How might these changes affect the business and retail banking market in Scotland, access to project finance, a reduction in competition on the ‘high street’ for lending, the plans for the retention of functions and ‘headquartering’ etc and what can the public sector in Scotland do to ensure the best possible result for Scotland?
  • What are the current employment levels and skills base in the financial sector in Scotland and how may these change? Additionally, what are the types of jobs that might be expected to be lost as part of any restructuring plans?
  • How are employment levels in the financial sector calculated at present, under what definitions and how do these relate to ONS figures? What changes are required to make employment figures more meaningful and comparable with other financial centres?
  • What are your views on the current efforts across the public sector in Scotland to respond to the recent difficulties in the financial sector in Scotland and what, if anything, needs to change in the future as the situation develops?
  • Has Scotland’s reputation as a global financial services centre been detrimentally affected by the global crisis and has this been to any greater extent than the problems felt in other financial centres?
  • How should Scotland differentiate itself and promote itself as a financial services centre in the future and what steps are being taken by our competitors in this respect?
  • How can we ensure that the Scottish financial sector continues to retain a global perspective and does not retreat into a purely localised lending regime?
  • Why are “new” banks choosing to establish themselves in Scotland, what is it that is particularly attractive and how can we build on this and attract additional investment into Scotland?

From whence we came: Scotland’s financial services sector in 2007

The impact of the global financial crisis on Scotland

7. The global financial crisis has had a profound impact on the financial services industry in Scotland primarily in our banking and building society sector. Scotland’s two largest banks, the Royal Bank of Scotland (RBS) and the Halifax Bank of Scotland (HBOS), survived only as a result of massive UK Government interventions, and, in the case of HBOS, a merger with Lloyds TSB. Scotland’s largest independent building society - the Dunfermline Building Society - was sold by the Bank of England under the special resolution regime provisions of the Banking Act 2009 following the intervention of the Financial Services Authority (FSA).

8. Other parts of the financial sector in Scotland, however, have better withstood the financial crisis. The Committee’s inquiry has provided evidence that the insurance, life and pensions, investment management and asset servicing sectors remain robust and Scotland retains global strengths in these activities. In evidence to the Committee, Jeremy Peat stressed the contribution that other parts of the financial sector made to the economy—

“We must not forget that the financial sector in Scotland has components other than banking and that several of them remain very successful, with high and well-deserved reputations. We must ensure that those elements of the sector continue to instil confidence in the economy. We must continue to respect those sectors and we should not focus all the time on the downside—on banks. There are positive stories elsewhere in the financial sector.”2

9. One of the Committee’s key purposes in conducting this inquiry was to establish a clear picture of the effect of the financial crisis on all parts of the financial services sector, with a view to providing a vision for the way forward. This section of the report covers the development and growth in Scotland of the banking and wider financial services sector in the years prior to the crisis.

10. The evidence presented to the Committee during its inquiry has driven us to return to first principles and to consider what purpose the banking and building society sector should serve in Scotland. In this context, the Committee believes that the words of Adam Smith, written in 1776 remain just as relevant today as they were then—

“It is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country.”3

11. The Committee considers that in addition to being an important business in its own right, the banking and building society sector in Scotland has to support the production of goods and services in the rest of the economy. The events of 2007-8 represent a catastrophic failure against this objective. The financial crisis and the resulting recession have undermined the economic growth agenda in Scotland. Unemployment has risen and further cuts in the public sector to reduce the national deficit seem inevitable. The Committee considers that it is important to manage the legacy of the financial crisis, ensuring that it never happens again and to develop a sustainable financial services industry that supports the rest of the Scottish economy both as an employer and as a provider of capital and other financial services to consumers.

From whence we came – the development and growth of Scotland’s financial sector before the financial crisis

The growth of the financial sector

12. Scotland has a long and distinguished history in financial services. By the late twentieth century, Scottish companies had developed strengths in banking, general insurance, life and pensions, investment management and asset servicing. Figure 1 shows that the financial sector experienced a period of substantial growth in the decade prior to the financial crisis, effectively doubling its Gross Value Added between 1998 and 2009.

Figure 1: Growth in Gross Value Added 1998-2009

Source: Scottish Government4

13. The growth in the financial sector, particularly the banks, had contributed to a concomitant increase in employment levels. Figures from the Office for National Statistics for 2007 show that 91,559 people in Scotland were employed in financial services, representing 3.8 per cent of the Scottish working population and 9 per cent of all financial services jobs in Great Britain.5 However, the Committee notes the written evidence submitted by Scottish Financial Enterprise which points out that there has been a downwards revision in the ONS figures over the last few years due to the use of changing definitions. In written evidence to the Committee, Scottish Financial Enterprise pointed out that a self-describing survey (where the respondent decided whether or not they work in financial services) resulted in a much higher figure of 145,000 employed in financial services in Scotland.6 The Committee therefore looks forward to the work currently being undertaken by the Fraser of Allander Institute on total employment in the sector, as well as its contribution to Gross Domestic Product. The Committee considers that this will help to provide more accurate statistics on the financial services sector.

The geographical concentration of the financial sector

14. The majority of financial services jobs have been concentrated in central Scotland. Annual Business Inquiry figures from 2008 show that Edinburgh and Glasgow had a 37 per cent and 32 per cent share respectively with the remaining jobs in financial services clustered in Stirling, Dundee, Fife, Perth and Aberdeen.7 The table below shows the number of businesses located in the central belt of Scotland.

Figure 2: Concentration of financial sector businesses in the central belt

Source: The Scottish Government8

Employment and earnings in the financial sector

15. The majority of employment in the financial sector has traditionally been in banking. Figure 3 below breaks down the number of employees in financial services into five key sub-sectors: asset management, banking, general insurance, intermediation and life and pensions. This demonstrates that banking is by far the largest sub-sector, employing 50,000 people in 2008, compared to a combined total of 45,500 in the other four sub-sectors.

Figure 3: Employment levels in the financial sector in 2008

bar chart

Source: Scottish Government 20109

16. Despite being lower than the UK average, median earnings in the financial sector are higher that in those in the Scottish economy as a whole. In April 2008, median earnings in the sector were £470 per week: 25 per cent higher that the median for all industries in Scotland. However, earnings were lower in the financial sector in Scotland than they were for the UK as a whole. Table 1 shows median earnings for April 2008.

Table 1: Median Earnings £ per week, April 2008

 

All industries Financial services Per cent of all industries
Scotland 374.7 470.0 125 per cent
Uk 388.4 530.8 137 per cent

Source: Office for National Statistics10 (NB Figures relate to jobs paid at adult rates not affected by absence)

Financial institutions in Scotland

17. The strength of the financial sector in Scotland prior to the financial crisis was boosted by the number of financial institutions which had a major presence in Scotland. The firms that had their headquarters or significant corporate activities in Scotland included RBS, Lloyds TSB Scotland, HBOS, Clydesdale Bank, Standard Life, Scottish Widows, AEGON UK, Aberdeen Asset Management, Alliance Trust and Martin Currie. Table 2 lists the main players in each of the sub sectors serving more than just the Scottish market.

Table 2: Financial Institutions with a Major Presence in Scotland

Banks and building societies Royal Bank of Scotland, Lloyds Banking Group, Clydesdale Bank, Scottish Widows Bank, Standard Life Bank, Nationwide.
Insurance and pension funding Standard life, Scottish Widows, AEGONUK, Bright Grey, Norwich Union, Prudential.
Fund management Aberdeen Asset Management, Alliance Trust, Artemis Investment Management, Baillie Gifford, Cornelian Investment Managers, First State Investment, Franklin Templeton Investments, Martin Currie, Ignis Asset Management, Scottish Widows Investment Partnership, Standard Life Investments.
Asset servicing Bank of New York Mellon, BNP Paribas Securities Services, Citigroup, JP Morgan, Morgan Stanley, State Street Corporation.

Source: Scottish Financial Enterprise

18. The presence of these financial institutions, particularly where they were headquartered in Scotland, has also promoted employment in associated business services, particularly the professions. The financial sector has supported high-end employment in legal services, accountancy, auditing, tax and management consultancy.

Exports of financial services

19. The financial sector has also contributed to Scottish exports abroad. Scottish Enterprise has estimated that exports of Scottish financial services outwith the UK are worth over £1.1 billion, but that the main market for the sector remains the rest of the UK.11 Data for exports to and imports from the rest of the United Kingdom (RUK) can be derived from Input-Output Tables. The most recent data relates to 2004 and shows gross exports to the rest of the UK of over £5 billion offset by imports from the rest of the UK of about £1.5 billion.12 Within the overall British context, Scotland’s key strengths were in life and pensions. Figure 4 shows the sub-sector percentages for Scotland of total British financial services.

Figure 4: Sub-sector percentages of total GB financial services 2008

bar chart

Source: The Scottish Government13

20. Thus, the overall picture of the financial sector in Scotland before the crisis was one of strength. Scotland was the second financial centre in the UK outside of London and in terms of Gross Value Added (GVA), the sector had doubled in size, providing valuable employment growth. The sector was diverse but with notable strength in banking, general insurance, life and pensions, investment management and asset servicing. The critical mass in each of these sub-sectors served to further reinforce the strength of the sector and attract inward investment into Scotland as UK or Global companies opened sited offices in Scotland.

21. The following parts of this section look more specifically at the banks; building societies; general insurance life and pensions; investment management and asset servicing sectors before the financial crisis.

The banking sector

22. The Bank of Scotland was established in 1695, only two years after the Bank of England. Its purpose was to support business in Scotland; in contrast to the Bank of England which was established to finance military spending by the English state. The Bank of Scotland was the first bank in Europe to print its own bank notes. The Royal Bank of Scotland was established in 1727 by Royal Charter. As joint stock-banks, which were not permitted in England until the 1833 Bank Charter Act, they drew on the increasing wealth of Scotland. They also became fiercely competitive as they expanded their role in Scotland and elsewhere. They remained dominant even though other banks, including trustee savings banks, entered the Scottish market.

23. In the 1980s, there was a period of significant consolidation in the UK banking and building society sector. The Royal Bank of Scotland was the subject of three individual takeover approaches by Lloyds, Standard Chartered Bank and HSBC but none came to fruition. Then, in 1999, the Bank of Scotland launched a hostile takeover bid for the National Westminster Bank, one of the “big four” English clearing banks. It was thwarted by a counter-offer by RBS in February 2000, making RBS the second largest banking group in the UK. Having failed in its bid for NatWest, the Bank of Scotland merged with the Halifax in 2001. Although this was presented as a “merger of equals”, and the bank’s headquarters were on the Mound in Edinburgh, the new institution was owned predominantly by Halifax shareholders. HBOS was the fifth largest bank in the UK, and pursued growth in its market shares aggressively over the next years to challenge the big four of RBS, HSBC, Lloyds TSB and Barclays. RBS, meanwhile, pursued an expansionist global agenda. By 2007, Scotland was home to two of the largest banks in the UK, one of which – RBS – was one of the largest banks in the world.

24. The banks in Scotland conducted a broad range of functions that were predominantly, but not exclusively, banking activities. These included retail banking, corporate banking, treasury, insurance services, actuarial services, consultancy services, mortgage services, investment management and corporate finance. The Scottish Government estimates that the banking sub-sector of the financial sector accounted for around 4.3 per cent of Scotland’s GDP prior to the financial crisis.14

The Royal Bank of Scotland

25. The Royal Bank of Scotland had grown significantly with its acquisition of NatWest. This not only increased the size of RBS in the UK, but also augmented it overseas, most notably bringing Greenwich Capital and the Ulster Bank into the Group. RBS grew these parts of the Group organically. In 2005, RBS entered a strategic partnership with the Bank of China and the RBS Coutts brand also helped to support growth in the Asia-Pacific region. The acquisition in 2007, of ABN AMRO – in a consortium with Fortis and Banco Santander – also contributed to the growth of RBS. However, the price paid for ABN AMRO, as well as the impairments that emerged within the parts of the ABN AMRO business acquired by RBS after the onset of the financial crisis, were to play a key role in the downfall of RBS.

26. In 2007, RBS’s profit (attributable to ordinary shareholders) was £6,823 million and its total assets were over £1,567,844 million. Worldwide, RBS employed some 172,600 people. Sir Fred Goodwin, the then Group Chief Executive of RBS, was positive in his review of 2007 contained in RBS’s Annual Report and Accounts. He stated that—

“For the Royal Bank of Scotland, 2007 was defined by another strong operating performance and by the acquisition of ABILLION AMRO. The diversity and quality of our business platform enabled us to deliver good financial results, with operating profit for the enlarged RBS Group rising by 9 per cent to £10,282 million. Our earnings momentum remained powerful, notwithstanding the impact of challenging credit market conditions in the second half of the year.”15

27. The size and market capitalisation of the RBS Group in 2007 made it one of the largest banks in the world with over 40 million customers in 53 countries worldwide.16 In 2007, it was named Global Bank of 2007 by The Banker. The breadth of RBS’s activities was evident in its key divisions, which were: Corporate Markets (including Global Banking & Markets and UK Corporate Banking), Retail Markets, Ulster Bank, Citizens, RBS Insurance, Manufacturing and ABILLION AMRO.

28. The positive outlook articulated by Sir Fred Goodwin was not to be enduring. In 2008, RBS was to face a combination of funding difficulties, toxic debts and post-acquisition write-downs and both the Chair and Group Chief Executive of Royal Bank of Scotland resigned.

The Bank of Scotland

29. The Bank of Scotland, which had been beaten by RBS in the acquisition battle for NatWest, had nevertheless become one of the largest banks in the UK following its merger with the Halifax. However, HBOS’s Annual Report and Accounts for 2007 already showed evidence of the impending crisis for the bank. Pre-tax profits had fallen by 4 per cent, although profit after tax increased by 4 per cent to £4.1 billion. The Chairman’s report for 2007 noted the impact of “market dislocation”—

“If ever the banks, regulators and ratings agencies needed a reminder of the importance of strong liquidity and strong capital, the second half of 2007 served as a wake-up call. Seemingly overnight we moved from a scenario in which the economic cycle looked set to play out in a relatively benign way, to one in which the credit crunch in the USA rapidly deteriorated into what is, as I write this, a worldwide credit liquidity dislocation.”17

30. However, later in his report, the Chairman predicted that “gradually this current market liquidity dislocation will pass” and that HBOS had welcomed the confirmation from the FSA of its status as an ‘advanced bank’ in accordance with the new Basel II capital requirements. The Chief Executive, Andy Hornby, also expressed his confidence in HBOS’s prospects due to the fact that it held 7.7 per cent of Tier I Capital under Basel II. Mr Hornby stated that he was “confident in our funding profile and capital base.”18 He set out his expectations for the bank’s performance in 2008—

“We expect financial markets to be difficult in 2008 but our combination of balance sheet strength, diversified business mix and stringent cost control, together with active margin stability, leaves us well positioned to take opportunities presented in these markets and deliver good growth in shareholder value over the next few years.”19

31. Thus, the Chairman and Chief Executive of HBOS recognised the impact that emerging credit crisis was having on the bank, but remained optimistic that their capital ratios, diversification of risk and cost reductions would help the bank to weather the impending storm. Indeed, HBOS still had ambitious growth targets at the beginning of 2008. Its priority was to grow its UK businesses and its market shares across all of its products to within a 15-20 per cent range of total market share. Whilst it had already achieved this in mortgages and savings, this represented a very ambitious target across the full range of its products within the divisions of retail and corporate, insurance and investment, international and treasury and asset management.

32. The events of 2008 were not to correspond to the expectations of either the Chairman or Chief Executive of HBOS as the bank’s capital ratios proved to be woefully inadequate to absorb the losses resulting from the risks that HBOS was exposed to due to its lending policies.

The Clydesdale Bank

33. In 2007, the Clydesdale Bank was the third largest clearing bank in Scotland, although its market position remained relatively small in comparison to the top two. The Clydesdale Bank was established in Glasgow in 1838 and grew throughout Scotland and northern England. In 1919, the Clydesdale was acquired by the Midland Bank, which continued to operate the bank under the Clydesdale brand name. In 1987, it was acquired by the National Australia Bank (NAB) as part of the latter’s purchase of the Midland Bank’s UK subsidiaries.

Lloyds TSB

34. The other main bank operating at a national level in Scotland was Lloyds TSB Scotland. The Lloyds TSB Group had been formed in 1995 following the merger of Lloyds Bank and TSB and in 2007, comprised the Lloyds TSB brand along with Cheltenham & Gloucester (one of the largest mortgage providers in the UK) and Scottish Widows (one of the UK’s largest providers of life, pensions and unit trust products). In Scotland, it operated as Lloyds TSB Scotland.

35. In 2007, Lloyds TSB was one of the largest banks in the UK, providing a wide range of banking and financial services - primarily in the UK - to personal and corporate customers. Its main business activities were retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. The Group had a smaller market share in banking in Scotland than for the UK as a whole.

Other banks

36. Other major banks such as HSBC, Barclays, and Abbey all had offices in Scotland, but their market shares were not on the same scale as those of RBS, HBOS or Clydesdale. There were also smaller-scale new entrants. Scottish Widows established a bank in 1995 and Standard Life in 1998, and both Tesco and Sainsbury established online banks offering a limited range of services in the 1990s.

Competition in the banking market

37. The statistics collected by the Office of Fair Trading (OFT) when it considered the Lloyds TSB acquisition of HBOS merger information, provide information (albeit rounded up or down to the nearest decile) for the market shares of the main banks in Scotland for personal current accounts and SMEs and SME start-ups prior to 2008. The table below shows the information provided by the OFT and demonstrates the greater market concentration in Scotland for personal current accounts and SME banking.

Table 3: Market shares of the PCA and SME market by the major banks in Scotland

 

Personal Current Accounts SMEs
(£1-£15m stock)
SME start-ups
HBOS 40-50 per cent combined for Lloyds TSB and HBOS 30-40 per cent 10-20 per cent
Lloyds TSB 10 per cent 10-20 per cent
RBS 20-30 per cent 30-40 per cent 30-40 per cent
Others <10 per cent each 10-20 per cent (nab group) 0-10 per cent (nab group and Banco Santander)
0-10 per cent each (Barclays, HSBC) 0-10 per cent other 10-20 per cent (others)

Source: Data in the OFT report to the Secretary of State on Lloyds TSB acquisition of HBOS

38. In evidence to the Committee, the OFT suggested that on the basis of the Competition Commission’s investigation into banking services to small and medium enterprises in 2000, there was evidence to suggest that while there were fewer banks in the market in Scotland, this had not raised the profits of the banks concerned and that, therefore, there had been no need to take action—20

“… when the Competition Commission looked at SME banking some time ago, it considered what remedies should be put in place because of the potential concerns. Interestingly, even though the Scottish market was more concentrated at the time of the Competition Commission's review, it did not find that firms were making excess profits, whereas it did find that in England and Wales. That was reflected in the remedies that were subsequently imposed. Although behavioural remedies were imposed throughout the UK, those on pricing, which the Competition Commission called transitional remedies, were imposed only in England and Wales. That reinforces the point that it is not necessarily concentration that causes bad outcomes in the market.”21

39. The Committee concludes that the evidence on market shares demonstrates that there was market concentration in personal current accounts and business banking in Scotland prior to the financial crisis. This is an issue that the Committee considers further in the report in relation to the divestments required of RBS and Lloyds Banking Group by the European Commission’s State Aid decision.

The building society sector

40. The building society sector in Scotland has historically been smaller than other parts of the United Kingdom. This partly reflected lower levels of owner occupation in Scotland until the 1980s and partly the comparative strength of the trustee savings bank movement. By the early twenty-first century, only three of the building societies that had been established in Scotland remained independent and headquartered here. These were the Dunfermline Building Society, the Scottish Building Society and the Century Building Society. The Dunfermline Building Society was by far the largest of these three financial institutions, with over thirty offices in Scotland. Its expansion had resulted from mergers and acquisitions of other financial organisations in Scotland. Other UK-wide buildings societies also had a presence in Scotland, most notably Nationwide, which had in excess of 40 branches throughout the country.

41. While trustee savings banks had proliferated all over Scotland in the late nineteenth and early twentieth century, these had also been the subject of acquisition and merger, eventually being absorbed into the Trustee Savings Bank and then into Lloyds TSB. The only independent savings bank remaining in Scotland is the Airdrie Savings Bank.

The general insurance, life and pensions sector

42. Outwith the banking and building society sector, Scotland has had a proud tradition in insurance, life assurance and pensions, investment management and more recently, asset servicing. In the 1990s, the life and general insurance industries entered a period of consolidation and many Scottish companies in this sector were taken over including General Accident, Scottish Amicable, Scottish Equitable, Scottish Life and Scottish Widows. However, Standard Life demutualised but remained independent and firmly rooted in Scotland and the new owners of other companies such as AEGON Scottish Equitable, Lloyds TSB (Scottish Widows) and Aviva (General Accident in Perth) have remained committed to Scotland.

43. Standard Life was the largest Scottish company in the insurance, life and pensions sector. It reported a year of strong growth in 2007, in which it superseded its operation and profitability targets. It then Chief Executive, Sandy Crombie observed that—

“Standard Life has delivered a very strong set or results in its first year as a listed company. We have beaten all our profitability and efficiency targets for 2007 and achieved record sales, a platform which we will build upon for further growth in years to come.”22

44. The business models used in insurance were different to those in banking, having more predictable and longer-term results. The insurance sector, which had undergone a crisis earlier in the decade, was also regulated differently. It was thus able to withstand the financial crisis more robustly than the banks.

Investment management and asset servicing

45. Investment management, which has its roots in the Investment Trust movement that grew up in the 1870s as a vehicle for world-wide collective investment and which was pioneered by a Scotsman, is well established in Scotland. The sector includes three distinct types of companies. Firstly, investment management arms of insurance companies managing the insurers’ own funds, retail products and pension funds. Scottish Widows Investment Partnership and Standard Life Investments are examples of this in Scotland. Secondly, independent investment management firms offering retail and pension fund management, such as Aberdeen Asset Management, Martin Currie and Baillie Gifford. Thirdly, Investment Trusts, which are collective forms of investment operating closed-end funds. The Scottish Investment Trust plc is one of the oldest oldest and largest independent, self-managed investment trusts, also the Alliance Trust PLC. It is estimated that over £580 billion of funds are managed directly from Scotland. Scotland’s investment management sector has extensive experience in areas including investment trusts, OEICs (open-ended investment companies), unit trusts, global equity, global fixed income, money market funds, private equity, venture capital, property funds, hedge funds, specialist equity and bond funds and emerging market funds. The client mix includes private clients, institutional mandates, retail funds, corporate pension funds, stakeholder pensions, personal pensions and charities from Scotland, the UK and internationally.

46. The strength of the investment management sector in Scotland has stimulated the growth of asset servicing over the last two to three decades, with a number of asset servicing companies including State Street, Bank of New York Mellon, Citibank, BNP Paribas, JP Morgan and Morgan Stanley choosing to locate in Scotland. The major global asset servicing organisations based in Scotland employ over 3,800 people in Scotland. Asset servicing companies handle the custody, administration, accounting and reporting of assets such as equities and fixed-income instruments for their clients, which are primarily investment management companies.

The legal framework

47. Under the Scotland Act 1998, 23 the regulation of the financial services sector is a wholly reserved matter and is the responsibility of the UK’s Tripartite Authorities: Her Majesty’s Treasury, the Bank of England and the FSA.

48. In 1997, the Bank of England’s responsibility for banking supervision was transferred to the FSA, which brought together the UK’s nine separate regulators. To ensure that the respective roles of the Bank and the FSA were clearly understood, and that effective arrangements were in place for “handling disturbances”, a Memorandum of Understanding was published in 1997 to provide a practical framework for cooperation between the Bank and the FSA, and for coordination between the Bank, FSA and the Treasury in the event of a financial crisis. Since the establishment of the FSA, Scotland’s financial institutions have been supervised primarily from its London office. In evidence to the Committee, the FSA emphasised that “we operate as the national regulator for the UK as a whole and do not regulate by country or region.”24

49. In written evidence to the Committee, the FSA set out the role of its office in Edinburgh—

“We also have an office in Edinburgh which provides visibility for the FSA in a city recognised as the UK's second largest financial centre after London. Staff in Edinburgh primarily supervise small retail firms, principally home finance brokers, general insurance brokers and independent financial advisors.”25

50. In evidence to the Committee, Jeremy Peat emphasised the responsibility of the Bank of England to the whole of the UK and questioned the extent to which the Bank engaged with Scotland—

“As far as the Bank of England is concerned, I have always taken the view that the monetary policy committee sets policy for the UK as a whole, so it is therefore responsible for ensuring that the UK and elements of the UK are reasonably satisfied that it is setting appropriate policy and taking account of variations across the economy. The original 1997 letter that established the committee refers to that spread. I have always been surprised that it has not been seen as appropriate for the Governor of the Bank of England or one of his colleagues to discuss how he and they are operating monetary policy across the UK and therefore within Scotland, and to listen and hear.”26

51. The Committee is of the view that the financial crisis has served to highlight the importance of financial supervision and an understanding of the different economic and banking environments that exist in different parts of the United Kingdom. We make recommendations in relation to the Tripartite Authorities later in the report.

An assessment of the financial sector in Scotland prior to 2007

52. By the summer of 2007, on the eve of the impending crisis, Scotland was the second financial centre in the UK after London and similar to the relationship of other important global secondary financial centres such as Boston in the USA and Melbourne in Australia. Unusually however, for a secondary financial centre, and notwithstanding its strengths in insurance, investment management and other financial activities, banks constituted Scotland’s largest financial services sector and this was to prove a source of vulnerability as the financial crisis played out.

The financial crisis and the subsequent economic recession

The crisis years: Summer 2007-Spring 2009

53. The series of events that occurred between the summer of 2007 and spring 2009 were to transform the financial sector in the UK. The scale of the events and the financial interventions made by the UK Government went far beyond what anyone had anticipated when the problems with sub-prime lending first emerged in the United States. As a result of the financial crisis, prevailing assumptions about the degree of supervision and regulation that are required for the sector have been completely revised and the G20 countries have recognised the need for coordinated global changes to the regulation of the financial system.

54. Between the summer of 2007 and the spring of 2009, the banking and building society sector in Scotland was profoundly changed. The UK Government became a major shareholder in Scotland’s two main banks (one of which had been acquired by Lloyds TSB) and the Dunfermline Building Society had been bought by the Nationwide. However, while banking suffered a major blow, the rest of the financial sector in Scotland was less hard hit and, as the later sections of this report shows, emerged relatively unscathed from the crisis.

The chronology of the financial crisis

55. The Committee recognises that the financial crisis has been the subject of many estimable and detailed accounts. This section of the report provides a chronology of the crisis and how it impacted on Scotland. This sets the context for the later sections of this report which focus on the lessons learnt and the way forward for Scotland’s financial services sector.

56. The Turner Review includes a table which sets out the key stages of the financial crisis between 2006 and 2009. It is reproduced below.

Table 4: stages of the crisis 2006-09

2006 – summer 2007
Localised credit concerns
Rising defaults in US sub-prime and Alt-a loans.
Falling prices of lower credit tiers of some credit securities. Expectations of property prices fall.
Summer – Autumn 2007
Initial crack in confidence and Collapse of liquidity
Failure of 2 large hedge funds. Spreads in inter-bank funding and other credit products rise sharply.
RMBS funding and inter-bank funding for second tier banks dries up. Northern rock faces retail run.
Autumn 2007– early Summer 2008 Accumulation of losses and Continuation of liquidity strains Severe mark-to-market losses in trading books. Collapse of commercial paper markets: SIVs brought back on balance sheet. Funding strains in the secured financing market. Worries about liquidity of major institutions Government assisted rescue of Bear Stearns.
Summer 2008
Intensification of losses and Liquidity strains
Mark-to-market losses and liquidity strains continue to escalate.
Housing market problems recognised as widespread in uk, us and other countries, as house prices fall and supply of credit dries up.
Fannie Mae and Freddie Mac increasingly reliant on us government support.
Funding problems of UK mortgage banks intensify.
September 2008
Massive loss of confidence
Bankruptcy of Lehmans breaks confidence that major institutions are too big to fail. Credit downgrade of AIG triggers rising collateral calls, requiring government rescue.
Mix of credit problems, wholesale deposit runs and incipient retail deposit runs lead to collapse of Washington mutual, Bradford & Bingley, and Icelandic banks.
Almost total seizure of interbank money markets; major banks significantly reliant on central bank support.
October 2008
Government recapitalisation, Funding guarantees and central Bank support
Exceptional government measures to prevent collapse of major banks; explicit commitments that systemically important banks will not be allowed to fail.
November 2008
Feedback loops between banking System and economy. Further government measures to Offset feedback loop risk.
Impaired bank ability to extend credit to real economy produces major globally synchronised economic downturn. Recession threatens further credit losses which might further impair bank capital.
Tail risk insurance – asset protection scheme.

Source: Financial Services Authority (2009) 27

57. Although this section of the report focuses on the period from the summer of 2007 onwards, when the financial crisis became visible in the UK, the Committee is aware of the early indications of the forthcoming crisis that were already in evidence prior to that date. In evidence to the Committee, Robert Peston - the BBC’s Business Editor - identified “two periods of delusion”. The first was that period up until the summer of 2007 when commentators began to pick up on some of the warning signs such as levels of indebtedness and leverage. The second period that Robert Peston identified was the year from the summer of 2007 onwards “when most of the authorities failed to appreciate the significance of the credit crunch and the economic harm that was being done by the massive contraction in credit that had been caused by the freezing up of the markets in that summer.”28 It was not until the “totemic” collapse of Lehman Brothers, in Robert Peston’s view, that “the world woke up to the fact that we faced a major crisis.” 29

Sub-prime lending

58. The first external signs of the financial crisis were rising defaults on sub-prime mortgage loans in the United States in the summer of 2007, reflecting a fall in US property prices. The price of credit default swaps – insurance policies against corporate failure – rose as confidence declined. In the autumn of 2007, liquidity in the wholesale banking market began to be affected as banks became reluctant to lend to each other. This caused problems for many British banks who, along with their global counterparts, lent out more to customers than they had on deposit and relied on wholesale funds to fill this gap.

Northern Rock

59. Northern Rock was the first UK bank to get into serious trouble. It sought emergency liquidity support from the Bank of England in September 2007, leading to customers queuing to withdraw funds. This was the body blow that alerted the financial sector and the governing authorities to the potential impact of the emerging financial crisis. As a consequence, the viability of banks in the UK came under greater scrutiny and confidence in the banking sector dramatically reduced. In February 2008, Northern Rock was taken into state ownership following the failure to find a purchaser willing to take it over. A major British financial institution had failed and required state rescue. The market had not been self-correcting after all.

Liquidity problems

60. From autumn 2007 until the early summer of 2008, liquidity remained tight in the inter-bank market and the cost of inter-bank lending was high. Mortgage-backed securities slumped and packages of debt that the banks had sliced, diced and sold on as collateralised debt obligations plunged in value. Banks had to reabsorb their structured investment vehicles which held these instruments onto balance sheets.

Bear Stearns

61. In the United States, Bear Stearns, which had had high exposure to mortgage-backed assets in the sub-prime sector as well as being involved in securitisation and asset-backed securities, received an emergency loan from the Federal Reserve Bank of New York. This proved insufficient to save the company and it was sold in distress to JPMorgan Chase. The collapse of Bear Stearns exposed the risks inherent to the Wall Street investment bank sector and served as a prelude to the meltdown of that sector in September 2008.

62. In the summer of 2008, market losses and liquidity strains continued to escalate. In the UK, house prices began to fall and the supply of credit dried up as the UK’s main mortgage lending banks’ funding problems hit the consumer.

Lehman Brothers

63. In the US, on 7 September 2008, Fannie Mae and Freddie Mac, two US-government sponsored entities, were placed into government conservatorship and provided with a capital injection of up to US$ 200 billion. 30 This was closely followed by Lehman Brothers filing for bankruptcy in mid-September. In evidence to the Committee, Irmfried Schwimann of the European Commission suggested that the bankruptcy of Lehman Brothers represented a watershed—

“When the crisis started with Northern Rock, and with IKB Deutsche Industriebank and Sachsen LB in Germany, we had the impression that faulty business models were being used and business decisions that were not particularly wise were being made. When Lehman happened, the situation clearly changed; trust went out of the system and we had a systemic crisis that called for different reactions and responses from the regulators, supervisors and competition authorities.”31

64. The collapse of Lehman Brothers had a profound effect on confidence. On 15 September 2008, the value of HBOS shares declined by more than one-third as financial stocks were hit by the fallout from the collapse of Lehman Brothers. The Lehman Brothers’ bankruptcy was soon followed by American International Group (AIG) suffering a liquidity crisis when its credit rating was downgraded. The US Federal Reserve Bank stepped in to provide a huge credit facility to allow AIG to meet increased collateral obligations resulting from the credit rating downgrade. The failure of these large American financial institutions caused global panic.

Bradford and Bingley

65. In the UK, Bradford and Bingley was nationalised by the UK Government at the end of September 2008 (although the savings side of the business was sold to Santander). Bradford and Bingley had relied heavily on the wholesale credit market for its funding and had moved from being a traditional building society into a lender specialising in buy-to-let loans, high loan-to-value mortgages and self-certification mortgages. Its mortgage book was taken on by the UK Government as Santander was unwilling to buy it without guarantees.

The Icelandic Banks

66. Over the previous decade, Iceland’s banks had used modern financial techniques to expand globally. For several years they appeared to be examples of the new financial paradigm proclaimed by free market supporters but the collapse of the wholesale banking and securitisation markets left them vulnerable. Their collapse was also felt in the UK. Within a matter of weeks, Landsbanki, the Glitnir Bank and Kaupthing all went into receivership. These banks, particularly the Icesave online subsidiary of Landsbanki, had attracted UK depositors and investors (including charities and local authorities) as a result of the high interest rates that they offered.32 In Aberdeen, a non-profit distributing public private partnership agreement for refurbishing and building schools had been signed with a consortium including Landsbanki and was threatened by the collapse of the bank. The crisis began to have an effect on foreign lending at this point, with foreign banks either withdrawing or reducing lending in the UK.

67. Robert Peston emphasised the effect that the financial crisis began to have on foreign lending—

“For example, the Irish banks are not lending what they were, because they have problems of their own; the American banks have retrenched to a large extent; and the Icelandic banks have disappeared. Further, all sorts of special lending vehicles collapsed or were wound up, particularly in the mortgage market. The Treasury calculated that, simply as a result of the withdrawal of credit from overseas and the collapse of many specialist vehicles, something like 50 per cent of lending capacity was taken out of the UK market.”33

68. The Scottish Government also expected that “a withdrawal from the economy of foreign lending, will impact on companies in Scotland.”34 However, there is no data available to help quantify the impact of the withdrawal of foreign capital on lending in Scotland.

The UK Government response

69. The run on Northern Rock, and its subsequent nationalisation, and the collapse of Bradford and Bingley were precursors to the crisis that was to hit two of the UK’s biggest banks in October 2008. The growing realisation of the potential scale of the crisis led to a UK Government announcement on 8 October 2008 to bring forward specific and comprehensive measures to ensure “the stability of the financial system and to protect ordinary savers, depositors, businesses and borrowers.”35 The measures were designed to provide sufficient short-term liquidity, make available new capital to UK banks and building societies to strengthen their resources permitting them to restructure their finances, while maintaining their support for the real economy; and ensure that the banking system had the funds necessary to maintain lending in the medium term.

70. The UK Government announced that at least £200 billion would be made available to banks under the Special Liquidity Scheme. The Bank of England would contine to conduct auctions to lend sterling for three months against extended collateral, reviewing the size of those operations as necessary. The Government also established a facility which would make Tier 1 capital available in appropriate form to “eligible institutions” (defined as UK incorporated banks and UK subsidiaries of foreign institutions which had a substantial business in the UK and building societies). A number of banks confirmed their participation in this Government-supported scheme, but within a week, it was clear that RBS and HBOS would be the recipients of direct state aid.

71. Following the UK Government’s announcement on 8 October, the scale of the crisis at RBS and HBOS began to unfold and over the weekend of 11-12 October 2008 and the UK Government took the critical decision to inject billions of pounds sterling in capital into these two banks in return for shares. Over that weekend, the UK Government bailed out Royal Bank of Scotland and Lloyds Banking Group (LBG), the merged entity resulting from the HBOS and Lloyds TSB merger, in order to prevent economic meltdown. In evidence to the Committee, the European Commission later commented on the size of the state aid received by RBS in the context of other banks that failed in the European Union, indicating that it was “much greater than that received by Lloyds, ING or KBC, which is itself quite big.”36

72. On 13 October 2008, HM Treasury announced that the UK Government was making capital investments to the tune of £37 billion in RBS, and upon successful merger, £11.5 billion in HBOS and Lloyds TSB.37 The UK Government bought £5 billion of preference shares in RBS and another £15 billion of ordinary shares. In return for the capital provided to HBOS, the UK Government acquired £8.5 billion in ordinary shares and £3 billion in preference shares, while Lloyds TSB received £5.5 billion. Thus, the UK Government took ownership of 70 per cent of the shares in RBS and 43 per cent of the shares in LBG. When the UK Government bailout was announced, the Chancellor described the rescue package as containing "essential steps in helping the people and businesses of this country and supporting the economy as a whole", while the Prime Minister indicated that it was "unprecedented but essential for all of us".38

73. The form of the UK Government’s protection for banks to avoid losses on their riskiest assets was announced in January 2009. The Asset Protection Scheme was part of a package of measures to support lending and further reinforce the stability of the financial system following the intensification of the global downturn. Banks entering the Asset Protection Scheme would receive protection for a proportion of their balance sheets in order to protect the healthier part of their commercial business and ensure that the banks concerned could continue to lend. While initially both RBS and LBG indicated their intention to enter the UK Government’s Asset Protection Scheme, it was only RBS that eventually did at the end of 2009.

74. The evidence heard by the Committee underlined the importance of the UK Government’s intervention. In evidence to the Committee, Jeremy Peat stated—

“It will be several years before we can get a firm view of what happened but, frankly, the interventions that took place in this country became absolutely necessary given the circumstances that pertained. If we had allowed two or three large banks to founder totally, it would have been catastrophic for our economy for an extended period. The intervention was necessary.”39

The European Commission State Aid decisions

75. On 18 November and 14 December 2009, the European Commission agreed its State Aid decisions for Lloyds Banking Group and RBS respectively.40 The EC State Aid decisions were negotiated between the European Commission and the Member State (in this case represented by HM Treasury). Evidence from a senior European Commission official confirmed that HM Treasury had included both RBS and LBG in the negotiations. There is no evidence that any representations were made by the Scottish Government to the European Commission on the State Aid decisions, although a senior European Commission official confirmed to the Committee that while the Member State was the normal interlocutor on State Aid decisions, the European Commission “would consider with interest any representation that a third party makes or any information that it provides.”41

76. The information released by RBS in November 2009 indicated that it would be required to dispose of 318 branches UK-wide (14 per cent of the Group's UK retail network) and the appropriate infrastructure to support this business. This consisted of the RBS branch-based business in England and Wales, the NatWest branches in Scotland, along with Direct SME customers across the UK. In addition, RBS Insurance, Global Merchant Services, RBS’s card payment acquiring business, and RBS's interest in RBS Sempra Commodities, a global commodities trader, would also be divested. Other, more behavioural requirements, included the restriction on RBS being no higher than number five in the combined global all debt league tables for 3 years.

77. Lloyds Banking Group indicated that it would dispose of a retail banking business with at least 600 branches, consisting of the TSB brand, the branches, savings accounts and branch based mortgages of Cheltenham & Gloucester, the branches and branch-based customers of Lloyds TSB Scotland and a related banking license, additional Lloyds TSB branches in England and Wales, with branch-based customers and Intelligence Finance.

78. The Committee believes that whilst it was clear form the evidence from the European Commission that competition in the Scottish banking sector was not a factor in their decision, the European Commission State Aid decision may result in a welcome opening up of the banking market in Scotland. Although the divestment by LBG of its Lloyds TSB branches will essentially return the competition position to that prior to the merger, the divestment will provide the opportunity for new entrants to the Scottish market. The Committee, while it supports the sustainability of the Royal Bank of Scotland and Lloyds Banking Group operations in Scotland, believes the banking market must be opened up for both personal and business customers. Not only will this offer more choice for consumers, but it will help to disperse the critical risk that became so apparent in October 2008 when Scotland’s two largest banks simultaneously collapsed. The Committee makes further comments on the diversification of the banking sector later in the report.

The impact of the crisis and the subsequent economic recession

Economic recession and unemployment in Scotland and the UK

79. The series of events that have constituted the financial crisis have caused the worst recession in the UK since the 1930s. The UK economy experienced six consecutive quarters of contraction (starting in the second quarter of 2008), only emerging from recession in the final quarter of 2009 when the economy achieved growth of 0.3 per cent.42 Scotland has had five quarters of recession (starting in the third quarter of 2008) and it will not be known until April 2010 whether Scotland also emerged from the recession in the last quarter of 2009. Figure 5 shows Gross Value Added in Scotland and the UK since the first quarter of 2008.

Figure 5 - GVA since Q1 2008 in Scotland and the UK

Source: Scottish Government43

80. Unemployment has also risen since the beginning of the end of 2008. Figure 6 shows the claimant count rate for unemployment in Scotland and the UK since the onset of the recession.

Figure 6 – Claimant count in Scotland and the UK since September 2008

Source: Office for National Statistics Nomis: Official Labour Market Statistics 44

81. There have also been other costs to the financial crisis. These include costs that may have hit people in Scotland disproportionately. Jeremy Peat elaborated on the impact of the crisis on Scotland in evidence to the Committee—

“The impact of the banking sector collapse has been dramatic across Scotland. We cannot overstate its impact on all aspects of economic life and on individuals. What happened was a traumatic shock and one that very few people anticipated, although we were all aware of the global imbalances in the economy. They existed when I left the Royal Bank of Scotland four and a half years ago. However, no one would have forecast the dramatic impact that resulted from those imbalances and from the decisions and activities in the banking sector and the economy.”45

82. Pensioners and savers in particular have been hit by the drop in share prices, the reduction in dividends and the continuing low interest rates. Institutional shareholders have also been hit by the decline in the value of shares. Standard Life, for example, was a major institutional shareholder in RBS. Consumer confidence in banks has been reduced and the Committee shares the public’s outrage at the large bonuses that high earners in the financial sector are still receiving.

83. Small and medium enterprises in Scotland have been struck particularly hard by both the financial crisis and the subsequent economic recession. Surveys of businesses, the Scottish Government’s SME Access to Finance reports and press reports all point to changes in the conditions attached to finance and the higher cost of obtaining finance. The Scottish Government’s survey published in March 2009 showed that while demand for finance had risen, the supply had become constrained, particularly for micro businesses, high-growth firms and within certain sectors. The self-employed in each sector were facing the biggest restriction in supply and the sectors that had experienced the largest decrease in approval rates were hotels/restaurants, business activities, wholesale/retail, construction and manufacturing.46 The updated survey, carried out in November 2009, indicated that many firms perceived that the cost of finance was higher and that refinancing was incurring increased costs.47 An Institute of Directors survey, published in February 2010, painted a bleaker picture. Of 1,045 directors surveyed in the UK, a quarter said that they had tried to access finance from the institutions that they banked with in 2009/10. Of this quarter, 57 per cent of directors indicated that their application for finance had been rejected by their bank.48

The cost of UK Government financial interventions

84. The National Audit Office (NAO), in its assessment of the measures taken to maintain financial stability across the UK’s banking system, concluded that “the public support provided to the UK banks by the Treasury was justified, given the scale of the economic and social costs if one or more major banks had collapsed.”49 The NAO listed the support provided by public funds. This included the purchase of £37 billion of shares in RBS and LBG in 2008 and an additional £39 billion in 2009.50 The Treasury also indemnified the Bank of England against losses incurred in providing over £200 billion of liquidity support and there was an agreement to guarantee up to £250 billion of wholesale borrowing by banks to strengthen liquidity in the banking system and £40 billion of loans and funding were provided to Bradford & Bingley and the Financial Services Compensation Scheme.51 In addition, £282 billion of RBS assets have been placed in the Asset Protection Scheme, although the taxpayer’s maximum liability under the scheme is just under £200 billion. The NAO also acknowledged that the scale of the loss to the taxpayer would only become known several years hence. The eventual cost will depend on any losses from the Asset Protection Scheme and the price at which the UK Government sells its shareholdings in RBS and LBG. The UK Government has consistently emphasised that it intends to recoup the cost of the interventions in RBS and LBG through UK Financial Investments’s (UKFI) eventual sale of the UK Government’s shareholdings.

85. Although the specific cost of the bailout of the Scottish banks is also unknown, the Scottish Parliament’s Information Centre (SPICe) has estimated that RBS and LBG were provided with £470 billion.52 SPICe also calculated that this figure was three times the annual Scottish GDP and that the total UK Government intervention of £751 billion was equivalent to a just over half of UK GDP.53

86. At a global level, it has been estimated that the actual and potential write down of assets held by banks will be US$3.4 trillion.54 The final cost of the bailout of the banks in the UK remains unknown, and indeed may never be calculable from official statistics. As the UK emerges, albeit slowly from recession, it has a large national debt. The Chancellor’s pre-budget report indicates that at the end of December 2009, Public Sector Net Debt (PSNB) was £870 billion, equivalent to 61.7 per cent of GDP. Net debt excluding financial interventions was £740.6 billion, equivalent to 52.5 per cent of GDP.55 This implies that the cost to date of the financial interventions is £129.4 billion. However, the pre-budget report indicates that the net cost is now expected to be around £10 billion, thereby suggesting that some £120 billion will be repaid or recovered. The International Monetary Fund (IMF) has estimated that the final cost of the UK Government’s financial intervention will be around £130 billion.56

87. The Governor of the Bank of England in a speech to business leaders at Prestonfield House in Edinburgh in October 2009, estimated the total cost of the financial interventions as being higher than the NAO figure—

“The sheer scale of support to the banking sector is breathtaking. In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion (that is, one thousand billion pounds), close to two-third of the annual output of the entire economy. To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”57

88. The Committee acknowledges the evidence that it collected in the course of the inquiry that emphasised that the UK Government is still pursuing a policy of fiscal expansion to alleviate the effects of the recession and act as a driver for economic growth. It notes that the “bill is yet to land on our collective doormat”58 and that there may yet be a public reaction in response to the requirement to realign fiscal expenditure to reduce the national debt.

89. The Committee accepts that the UK Government’s financial intervention was necessary to prevent economic turmoil and agrees with the head of the UK’s NAO in concluding that—

“It is difficult to imagine the scale of the consequences for the economy and society if major banks had been allowed to collapse. The Treasury was justified in using taxpayers’ money to safeguard savings and stabilise and restore confidence in the financial system.59

90. The Committee recognises that while the financial crisis is a global crisis, the UK Government has had to intervene on a huge scale to support the financial sector and alleviate the effects of the financial crisis on the broader economy in the UK. Notwithstanding the UK Government’s actions, the UK has experienced six successive quarters of recession and an increase in unemployment levels. The financial crisis has triggered the deepest recession in the UK since the 1930s.

91. The Committee deplores the fact that it was necessary to intervene with on such a scale with public funds to provide capital to RBS and Lloyds Banking Group as a result of the failings of these two banks. Whatever the final cost may be of the banking bailout, it is clear that enormous sums of capital were required at short notice from the state to prevent RBS and HBOS/Lloyds Banking Group from collapsing. The state should not be required to intervene ever again on this scale to prevent the failure of private financial institutions. It is not acceptable that losses have to be met by the public sector when so much of the profit remains in private hands. Nevertheless, the Committee believes that the UK Government’s financial intervention in the banks served to prevent an incalculably larger economic crisis.

92. The Committee recognises that the headquartering of the two main UK banks that failed - HBOS and RBS - in Edinburgh made Scotland potentially very vulnerable in the context of the financial crisis. The effect on the Scottish economy and society of the failure of either or both of these two banks would have been enormous. Moreover, the market domination of these two banks in Scotland meant that the failure of either of them would have had a disproportionate effect on personal current account holders, those with home loans, businesses and on the Scottish individual and institutional shareholders which held shares in these banks. A failure would also have resulted in massive and widespread redundancies throughout Scotland.

93. The Committee therefore returns to the words of Adam Smith and calls for a banking sector that renders the capital of the country more active and productive and that, through the judicious operations of banking, increases the industry of the country. Individual banks can never again be allowed to be so important that their failure can endanger the real economy of a country. Never again can banks and the financial sector be able to hold a gun to the collective heads of the taxpayer where the consequences of their failure are too terrible to imagine.

the causes of the financial crisis

94. The Committee recognises that there are an ever-increasing number of analyses of the causes of the financial crisis and commentaries on what has, and what has not, been learned from the crisis. We have not set out to reproduce another exhaustive analysis of what went wrong. However, whilst this inquiry has focused on the way forward for Scotland’s banking, building society and financial services sector, the Committee’s starting point was the need to assess the impact of the crisis in Scotland in order to consider the future for the financial services sector in Scotland. The Committee also considers that as Scotland’s financial services sector will be shaped by the regulatory responses to the crisis - whether these are at the UK, European Union or global level – it is important to consider the potential impact of these responses.

95. This section of the report considers the key causes of the crisis in order to set the context for the later sections of the report which focus on the lessons learned and how Scotland can help support its financial sector in the future.

The ascendancy of money

96. The Committee considers it important to stress that many were complicit in the assumptions, values and behaviour that underpinned the culture and philosophy surrounding financial sector in the run-up to the crisis. Those that were complicit included the governments of all shapes and forms that welcomed the large revenues that they received from the sizeable profits made by financial institutions; those that unquestioningly accepted the free market philosophy that markets always work and that government intervention does not serve a useful purpose; regulators who failed to adequately supervise financial institutions; financial institutions that abandoned time-honoured principles of basing lending primarily on deposits; non-executive directors that failed to scrutinise the management practices of financial institutions; shareholders who pressed for higher yields and consumers that built up unprecendented levels of personal debt.

97. The Committee recognises that, with the benefit of hindsight, a number of causes of the financial crisis have been identified. In evidence to the Committee, both Gillian Tett and Robert Peston highlighted the fact that while the warning signs were in evidence, they were not acted upon. Robert Peston emphasised the way in which many welcomed the “explosive growth” in the financial sector—

“There were lots of warning signs that lots of people picked up in different ways. You will all remember the concerns that were widely raised about the fact that British households were borrowing far too much. It was no great secret that the indebtedness of households rose to more than 170 per cent of their disposable income—an all-time record by a mile. That was visible. Also, although it rarely got off the pages of specialist publications or outside the last page of the Financial Times, the $60 trillion notional size of the credit derivatives market—which turned out to be something of a problem—was well known within the central banking regulatory world, yet its explosive growth was simply allowed to continue. In fact, far from trying to limit that growth, people such as Alan Greenspan were on the record as saying that those innovations were good things.”60

98. Gillian Tett, assistant editor of the Financial Times, suggested that the “social silences” that surrounded the banking sector before the financial crisis were indicative of a broader interest in allowing the sector to grow in a “light-touch” regulatory environment—

“What really matters in that respect is not simply what is discussed in public but what is not discussed. In recent years, it was incredibly important that the financial industry and the political elite signed up to the view that deregulation was good and that we should let bankers get on with banking without asking too many difficult questions, because free markets would fix everything. It was equally important that, as bankers got on with their banking, very few people were looking closely at what they were doing—there were a lot of social silences. My key point is that neither bankers nor most people outside banking were aware of those social silences. Partly as a result of that, large parts of banking carried on unchecked for years, without people asking questions.”61

The prevailing philosophy

99. The Committee considers that the lack of action taken in response to the warning signs reflected the prevailing philosophy or culture at the time. It is significant that Alan Greenspan (former Chairman of the Federal Reserve in the US) chose never to repeat the use of the term “irrational exuberance”, a phrase he coined in 1996 to warn against the overvaluation of the stock market, for irrational exuberance was a key cause of the crisis. It was evident in the overwhelming faith he and others put in the financial sector, in the quest for more perfect markets that underpinned the relentless pursuit of returns and growth, and in the development of ever-more complex financial instruments. Governments meanwhile, allowed their critical faculties to be dulled by the substantial tax receipts that were flowing in as a result of huge profits in the sector. In evidence to the Committee, Adrian Coles of the Building Societies Association observed that the “issue is the way in which the entire system interacted…It is about the culture that has developed during the past 12 years.”62

100. The financial sector was not reserved in commending its contribution to the UK economy. In 2007, the Chief Executive of the British Bankers Association summed up the sector’s contribution in the following terms—

"The financial services industry in the UK creates millions of jobs, generates wealth for the UK's citizens, contributes some £23 billion to the exchequer and provides the economic infrastructure which allows our entrepreneurs and businesses to grow. Without the global success of British banking there would be a gaping hole in the nation's finances and in people's pensions. It really is the engine room of the economy."63

101. This overriding belief in the value of the sector and its contribution to the economy more broadly was one that appeared to be almost universally shared. Robert Peston emphasised the degree to which growth was welcomed not only by government, but also by the economy more broadly and consumers—

“Let us be clear. In some sense almost everyone was implicated in the bubble, whether it was people buying a house at the top of the market with a 100 per cent mortgage, or the Chancellor of the Exchequer loving all that tax revenue that was coming from the city and not looking under the bonnet at what the city was actually up to, or the newspaper groups getting lots of lovely advertising from estate agents and property supplements or television companies getting lots of lovely viewers for programmes telling them to go out and buy another house to do up. I am afraid that, as a society, we were all implicated in the bubble.64

102. Gillian Tett considered that this faith in the financial sector and the way that this contributed to the crisis was “a structural and systemic problem” which went far wider than just the banking sector itself. She argued that the pervasive culture influenced a number of different institutions, influencing their behaviour towards the financials sector and making them all party to the failure of the sector—

“If you draw up a list of the institutions that have been shown by the crisis to have failed in some way in the past decade or so, it would definitely include auditors, regulators, politicians and rating agencies, alongside bankers. There were shortcomings in many parts of the system. People tend to focus on the bankers because, of the many groups on that long list, they were the only ones to walk away with gazillion-dollar cheques. 65

103. Bryan Johnston, an investment manager, also expressed the view that responsibility for the financial crisis has to be widely shared—

“It was evident what was going on in the banking sector. The Government gleaned vast amounts of taxation from banks and bankers directly and did not appear to question where that revenue was coming from. Shareholders enjoyed the benefits of the rising share price without questioning its long-term sustainability. I am not looking to pick anybody out and say, "It is them; it is their fault." I believe that we are all to blame and are all culpable. We should all learn, but none of us will.”66

104. Stephen Hester’s interpretation of the situation prior to the crisis was that there was a “democratic dilemma”. He posited that—

“…none of us is good at voting for a poorer present in favour of a safer future. It is hard for politicians to make it into office by telling people to deny themselves today. That is a hard thing to do, because people are not good at denying themselves today. However, the things that went wrong were visible to everyone.”67

105. The Committee believes that this prevailing philosophy was to provide the perfect environment for promoting the ambitions of the financial service sector. The quest for growth in a competitive market was not questioned, nor were the instruments for achieving that growth. The UK financial sector took advantage of this to compete internationally, most notably by using light-touch regulation as a means of building up London as a European competitor to New York. Low global interest rates caused investors to chase yield and this in turn promoted the development of complex derivatives. Underpinning this was the conventional wisdom that “the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient.”68

106. Evidence submitted to the Committee by HM Treasury identified “the failure of the tools of market discipline, in particular of corporate governance, risk management and remuneration” as a key cause. Corporate governance standards were compromised by the pursuit of yield in this highly competitive market. HM Treasury considered that “firms’ senior management must carry primary responsibility for their actions and resulting consequences”. However, it also recognised the “widespread failures of governance by some bank boards in several areas, including:

  • understanding and probing overall risk-management reporting;
  • understanding how affiliated vehicles imply ongoing exposure; and
  • how remuneration policies encourage risk-taking that may prioritise the short term at the expense of the long term.”69

107. The failure of non-executive directors to challenge the management of financial institutions was identified by the STUC as a key factor which contributed to the crisis—

“Bank boards were either incapable of identifying, or unwilling to object to, the unsustainable business strategies being pursued by those whom they supposedly had a duty to oversee. It is difficult to escape the conclusion that the primary cause of the recent problems in the Scottish banking sector was this abject failure of corporate governance.”70

108. Remuneration practices in some areas of banking reflected the overriding importance attached to innovation and achieving profit. Bonuses in areas such as investment banking were awarded on the basis of annual as opposed to longer-term performance. The STUC expressed the view that “there can be little doubt that the bonus culture encouraged excessive risk taking in an already fragile system.”71 HM Treasury also noted that “staff in certain areas of banking were incentivised through the possibility of very large rewards to pursue unduly risky practices that, although profitable in the short term, did not take appropriate account of risk in the long term.”72

109. The Committee also considers that the complexity of financial institutions and the instruments that began to proliferate in the decade before the financial crisis posed a problem both for regulators and commentators and served to screen potential risks and prevent the prevailing philosophy from being questioned sufficiently. In this context, the Committee recognises the need that Gillian Tett identified for ‘cultural translators’ who can provide “a specific expert view to understand the silos and a general vision of how all the bits add up and create risks.”73

110. The Committee is of the view that the financial crisis had many and varied causes, but few remain innocent of the charge of not having bought-in to the opportunities and quick returns offered by a globalising banking environment. To paraphrase, greed was seen as good.

Global factors

111. All of this was happening in the broader context of growing global imbalances which were creating instability. China, Japan and a number of oil-producing countries accumulated current account surpluses while countries in the west, including the UK and the US, accumulated debt. By the early summer of 2008, it was clear to many in the financial sector that the “credit crunch” resulting from overexposure of financial institutions in the United States to sub-prime mortgages was going to have a more profound global impact.

112. The Turner Review identified the factors behind these imbalances—

“A key driver of those imbalances has been very high savings rates in countries like China; since these high savings exceed domestic investment, China and other countries must accumulate claims on the rest of the world. But since, in addition, China and several other surplus countries are committed to fixed or significantly managed exchange rates, these rising claims take the form of central bank reserves.”74

113. In evidence to the Committee, Jeremy Peat stressed the contribution that these capital surpluses made to promoting more readily available credit in the west. He also noted that “the economy had been so successful in macro terms for so long that there was a degree of complacency on all sides” that the imbalances could be corrected—

“What I was referring to in my earlier comments was being aware of the global imbalances and the extent to which the United States, the UK and Europe were consuming on the basis of savings in China and elsewhere, and the extent to which the private sector and individuals were consuming and buying more assets than they had a sustainable basis to do. There was a need to correct those imbalances, and it was never clear exactly how that was going to happen. Monetary policy was kept very loose for a long time, which exacerbated the growth of the imbalances, and something had to be done to correct them.”75

114. Stephen Hester observed that the global imbalances were not “hidden things”—

“Anyone sensible should have known that the UK could not spend its entire time driven by consumer spending that was funded by withdrawal of equity from house prices spiralling ever upwards. Everyone should have seen that huge Government balance of payments deficits in the west financed by the east were not sustainable. Everyone should have seen that the explosion of commercial property development in Spain and in Ireland was not sustainable.”76

115. The Committee recognises that global imbalances provided a context for the financial crisis and that these imbalances resulted in the UK borrowing more than it saved as a country. The Committee notes that as a result of the financial crisis, these global imbalances have increased yet further.77 Western countries seeking to raise capital have become further indebted as they seek sovereign purchasers with current account surpluses to buy government securities. The financial crisis and subsequent economic recession has served to increase both the national debts of many western nations and the proportion of that debt that held by other countries, most notably China. If, as many commentators have emphasised, global imbalances were a key factor in the current crisis, the Committee is of the view that this issue has not yet been addressed sufficiently by those western governments with large sovereign debts and that it should be a key objective of Western government to reduce their deficits if we are not to be storing up more problems for the future. Gillian Tett observed the continuation of this trend very succinctly in evidence to the Committee when she stated that that, “there are huge imbalances in the world today, and it would be naive to imagine that they will work themselves out smoothly.”78

The globalisation of the banking world

116. Over the two decades preceding the financial crisis, the free movement of global capital and its need for a vehicle to transmit that capital had acted as a driver for the growth and the development of global banks. However, there was no parallel globalisation of the mechanisms to regulate these global banking conglomerates; they largely remained domestically regulated. In addition, there were few adequate resolution regimes for financial institutions. The Committee observes that a key paradox of the crisis was that banks went out into the world to expand their operations and take advantage of the enormous wealth to be gained in a global market, but that they came home to die and it was national governments that bailed them out.

117. In evidence to the Committee, Gillian Tett commented on the way in which the need for “a way to cope with big banks when they are going bust, and to let them go bust without potentially dragging down the entire financial system” exacerbated the crisis. She observed that the lack of effective resolution regimes was particularly acute in relation to cross-border banks, questioning “If you do not have an effective cross-border mechanism, what are you going to do in a crisis?”79 She explained the particular problem that had emerged in relation to the bankruptcy of Lehman Brothers—

“One problem that we discovered with Lehman Brothers, for example, was that it had a big operation in London. As many of you will know, at the last minute it transferred billions of dollars to the US. It was not really clear who owned that money, and that issue has been a complete nightmare in trying to wind down Lehman Brothers. That is not the only example. In the case of the European bank Fortis, several different Governments grabbed its assets at the same time and pledged them as collateral, partly because when it ran into problems it was not clear who owned it or how it would be wound down."80

118. Where international provisions were in place, the financial crisis has demonstrated their inadequacy. Basel II was issued by the Basel Committee on Banking Supervision in 2004 to create an international standard that banking regulators could use when creating regulations about how much capital banks needed to protect against financial and operational risk with the objective of protecting the international financial system from the impact of a collapse of one of more major banks Unfortunately banks were able to comply with the letter of the Basel rules whilst evading their spirit and the financial crisis was to demonstrate how inadequate the capital reserves of banks were in terms of the risks generated by financial institutions.

119. Robert Peston suggested to the Committee that the ways in which banks had tried to avoid the Basel accords also contributed to the financial crisis—

“The failure was also a result of the Basel I and Basel II accords, which set global standards for banks' capital and liquidity requirements but also encouraged banks to game the system and do all sorts of silly things to get round the rules. They were an attempt to micromanage banks but, on the whole, banks are smarter than regulators and were able to get round the rules to a horrific extent. Of course, it turned out that they were not as smart as they thought they were…I think that the global rules were part of the problem, and they certainly need fixing.81

120. In many cases, global banks had simply outgrown their national environment. With balance sheets that equated to substantial percentages of GDP, the collapse of individual banks caused the contagion of the real economy in many countries. No state has felt the consequences of this phenomenon more acutely than Iceland, where the assets of its three failed banks were equivalent to 7.7 times the size of Iceland’s GDP.82 In Ireland, the assets of the three main banks were equivalent to 2.6 times the size of Ireland’s GDP. In Scotland, the total bank assets for RBS and HBOS alone in 2008 represented a ratio of over 20 times the Scottish GDP (and a figure of just over double the UK GDP).83 The Committee has noted the impact of the crisis on the UK GDP above, and remains concerned about the ratio of the balance sheets of these banks in relation to the size of the economy and the contagion that they could cause in the economy. The Committee believes that this raises two fundamental issues in relation to the reform of the banking system: the issue of “too important to fail” and the principle that the bigger or more important a bank is, the safer it has to be.

Sub-prime lending

121. It is generally recognised that the bursting of the American house price bubble was the trigger for the financial crisis. The imbalances in the global economy allowed the flow of funds into the US from countries with current account surpluses such as China, Japan, Germany and some oil producers. This had the effect of making credit more freely available and on easier terms. Lending, particularly in the form of mortgages, was provided to borrowers who were high-risk in terms of their capacity to repay the mortgage, especially if interest rates increased or property values declined. Linked to sub-prime lending was the massive increase in the number of mortgage-backed security agreements in circulation.

122. The tipping point came in 2005-6 when housing prices in the US peaked and then subsequently declined, with individuals beginning to default on their loans. Banks that had invested in sub-prime mortgage-backed securities began to experience sizeable losses. Defaults and losses on other loan types also increased significantly as the crisis spread from the housing market to other parts of the economy. Defaults and foreclosures in the US were to have an impact on banks throughout the world, spreading systemic risk, especially as sub-prime mortgages had been incorporated into collateralised debt obligations (CDOs). In the period between 2002 and 2006, CDOs became increasingly complex and prolific, with tranches of lower quality loans pooled together in CDOs which were assigned an overall AAA rating by ratings agencies. The widespread trading (and hedging of CDOs) meant that sub-prime mortgage risk in the US infected banks all over the world and resulted in significant losses for banks and a consequent decline in capital and a tightening credit in the availability of credit.

123. The evidence presented to the Committee pointed to inadequate risk assessment of CDOs. Richard Hunter of Fitch Ratings acknowledged that there was insufficient consideration of potential macroeconomic factors in the attribution or ratings to CDOs containing mortgage debts and that “our estimates on residential mortgage foreclosures, particularly in the US, were off.”84 When the sub-prime crisis hit, its scale and geographical spread demonstrated the inadequacy of the macroeconomic assumptions that had informed the ratings given to CDOs as AAA rated securities collapsed and spread counterparty risk.

124. The Committee considers that sub-prime bubble served to highlight the lack of realism in the pervasive expectation that property prices would continue to increase and that interest rates would remain low, as well as the assumptions that securitisation would disperse, and not spread, risk. Furthermore, the abandonment of sound lending and risk-assessment principles had saddled individuals with large debts that left them bankrupt or homeless.

125. The Committee notes that the “irrational exuberance” surrounding securitised products encouraged those that were developing and trading in them to overlook their complexity and focus on short-term profits. The Rt. Hon John McFall MP described this phenomenon to the Committee as “a brave new world of securitisation”.85 Robert Peston, in evidence to the Committee, recounted how senior bankers had failed to explain credit derivatives and collateralised debt obligations in simple terms to him in interviews. He observed that—

“The serious point about that is that, if an individual who does that cannot explain it in language that we can understand, it makes me worried that he does not know what he is doing. Further, as you will all know, the people at the top of those organisations did not understand what those highly paid employees were up to either. The way the system worked was that they employed risk managers, who employed other risk managers who talked to the traders and collated and processed the information in a way that could be fed up to the top board. At the end of the day, the board got what you might call a sanitised version of what was going on, which did not give them a handle on the risks that were being taken. That was plainly a disaster.”86

126. Stephen Boyle of RBS also recognised that the process of securitisation “was not well understood by the market participants or the regulators.”87 He explained that while—

“[the] techniques and products that were ostensibly designed to reallocate risk around the system and disperse it and guard against systemic risk had the opposite effect from what was intended. In fact, the risks ended up being concentrated in some cases back on the balance sheets of banks.88

127. HM Treasury singled out poor risk-management as a key contributor to the global financial crisis. It stated that “firms around the world failed to understand the nature and extent of the risks to which they were exposed – particularly the reaction of other institutions to remote rules and the correlation of risks across different markets.”89

The decline in ‘originate and hold’ banking

128. Consolidation in the banking and building society sector in the last two decades of the twentieth century was accompanied by a move towards an ‘originate and distribute’ banking model. Previously, banks and building societies had lent money to individuals and businesses and then collected their repayments themselves, thus creating an ongoing relationship with a customer. The bank or building society that originated the loan also retained the loan. The Committee observed that while the former ‘originate and hold’ model was still in evidence in the lending practices of some building societies, this practice and the relationship that emanated from it, was far rarer in banking.

129. Adrian Coles of the Building Societies Association emphasised the way in which the culture of innovation influenced some building societies – including the Dunfermline—

“More specifically, there has been a culture in which institutions have felt that they ought not to fall behind, and that has infected some building societies. If you stuck to the knitting, you were viewed as boring and backward, and not competing properly, and you suffered. That view unfortunately infected the management of some of the banks and building societies - Dunfermline is not the only building society that has faced difficulties during the past dozen years or so.”90

130. In moving away from ‘originate and hold’ banking, banks developed a practice of selling on their loans, which had the added advantage of making more credit available to other potential borrowers. This has become known as the ‘originate and distribute’ model. This allowed those banks to grow their lending business faster than would otherwise be possible on the basis of their deposited capital or shareholder investment. Banks could thus increase their profits and offer products on more attractive terms.

131. The Committee heard that diversification in the building society sector had been encouraged by the need to compete with the banks and how this contributed to problems faced later by some of the building societies that had demutualised and departed from an ‘originate and hold’ model—

“A traditional building society, of which Nationwide is a good example, has limited diversification. The market is entirely self-sufficient when the rate of return that a building society needs is only about capital self-sufficiency, because it is not answerable to an equity market or a set of shareholders. When such a building society is converted to a public limited company that, rightly for that model, has institutional shareholders demanding equivalent returns to those of diversified banking institutions, that institution has no argument not to diversify.

“The seeds of the failure for those building societies that converted were sown at the point of conversion. They would never have been able to make sufficient return to compete against global banking institutions. … That is also why some of the businesses that converted chose not to convert independently, but to sell themselves to maximise value for the owners of the businesses at the time. The kernel of the issue for the societies that converted is that they were forced to take risk in a relatively contracted market - that is, over a relatively short period - without an appropriate risk seasoning in their balance sheets.”91

132. In the course of the financial crisis, banks and building societies that were more exposed to the wholesale markets proved to be more vulnerable. The increase in the percentage of mortgage-backed securities issued by banks in the US resulted in banks from all over the world buying them. When mortgage defaults increased in the US, banks realised that there was a real risk that they would not be repaid on the loans that they had bought and the value of these loans became difficult to ascertain.

133. The ‘originate and distribute’ model propagated moral hazard in the banking system. Banks that sold on their loans had less incentive to apply rigorous risk-management systems, and the use of CDOs allowed riskier debt to be packaged up with safer debt and achieve a higher overall credit rating. For banks, the incentive became to achieve volume in lending in order to maximise the capital that could be gained from selling the loans on. This motivated aggressive marketing of loans and consumers became able to access credit to a degree which had never previously been possible, resulting in the ratcheting up of consumer debt. The wider effects on the economy should not be ignored, with house prices driven upwards by the increasing availability of capital.

Declining credit standards

134. The aggressive marketing of loans and products was also promoted by banks’ reckless ambitions. The availability of credit and low interest rates promoted a competitive lending environment in which banks could win market share by offering more attractive terms and conditions to their customers, often by reducing the credit standards attached to loans. In evidence to the Committee, the FSA identified “declining credit standards both in the household and corporate markets” as a one of the origins of the financial crisis.92 Banks abrogated appropriate lending and risk-management systems in the pursuit of market shares.

135. The decline in credit standards was also to ultimately result in banks experiencing heavy losses on their “toxic assets”. The Committee considers that the aggressive marketing of loans, both to individuals and businesses, was economically and socially irresponsible. This encouraged individuals and businesses to take on debt for which they potentially could not afford the repayments in the event of an increase in the interest rates. This was particularly in evidence in the development of the buy-to-let market. The FSA identified this exposure as a key cause of the financial crisis—

“The rapid extension of mortgage credit and of commercial real estate loans developed into a boom where rising property prices drove the demand and supply of mortgage credit, resulting in even higher property prices. The widespread extension of credit on terms that could only be justified on the assumption of future house price appreciation was particularly symptomatic of the US sub-prime market.”93

136. Data for the years prior to the crisis shows the significant increases in both personal and corporate debt levels in the UK. Table 5 below shows the increase in personal and corporate borrowing between 2001 and 2008. This increase in the amount of debt assumed by both individuals and businesses in a period of strong economic growth was to make them more vulnerable in changing economic circumstances.

Table 5 – Increase in personal and corporate borrowing 2001-08

£bns Personal sector borrowing Corporate borrowing
  Consumer credit Loans secured against dwellings Loan Liabilities of Private Non-financial Corporations
2001 150.8 591.4 617.4
2002 169.2 675.2 682.9
2003 180.6 774.6 728.5
2004 198.9 882.8 815.4
2005 211.0 967.0 949.6
2006 212.8 1078.8 1094.7
2007 221.7 1187.2 1159.7
2008 233.2 1226.3 1294.4

Source: ONS Financial Statistics Tables 3.2B and 12.1B94

137. The Committee heard evidence from Rob MacGregor of Unite the Union about the pressures that banking staff in the retail sector were under to market and sell products in order to achieve their performance targets and increase profitability—

“Over the past 10 to 15 years, our members have seen an unprecedented drive for retail financial services to deliver higher and higher levels of shareholder value. It was a significant cultural change. The banks have always made money out of retail banking - there is nothing new in selling loans and insurance products - but the drive to increase sales to generate more and more profit was unprecedented. The intention was to deliver record profitability year on year, irrespective of the economic climate and the impact on consumers.”95

Leverage and the shadow banking sector

138. Leverage96 in the banking and shadow banking sector was escalated to the extent that it “threatened the stability of the system as a whole.”97 Investors were using borrowed money to invest as they could potentially earn more from the investment than the cost of the actual loan itself. However, just as leverage magnified returns, it also proved to magnify debt, to a degree that caused significant losses and even bankruptcy. The failure of institutions to honour payments on debts was to spread contagion via counterparties within the financial sector.

139. There was also an expansion in the securitised credit that was held by off-balance sheet vehicles in the shadow banking sector rather than by traditional investors. With the onset of the financial crisis, the defaulting on leverage-linked payments was to cause losses to spread between banks. The Committee considers that the increase in leverage was another example of the high-risk and greedy practices engaged in by banks to maximise profits, the consequences of which were to spread debt through the banking system.

140. The FSA noted in written evidence to the Committee that increasing leverage in the banking and shadow banking system was a key factor in the crisis—

“[the] increasing scale, size and complexity of securitised markets was accompanied by a significant escalation in the leverage of banks, investment banks and other off-balance sheet vehicles, and the growing of hedge funds. Large positions in securitised credit and related derivatives were increasingly held by these institutions, rather than passed through to traditional, hold-to-maturity investors. This ‘acquire and arbitrage’ model resulted in incurred losses falling on banks and investment banks involved in risk maturity transformation activities. The rapid and very significant growth of the financial system resulted in financial sector balance sheets becoming of greater consequence for the economy, with financial sector assets and liabilities in the UK and the US growing far more rapidly as a proportion of gross domestic product than those of corporates and households.”98

Regulatory failure

141. The UK supervisory system has frequently been described as “light touch” in the years before the economic crisis. However, in evidence to the Committee, John McFall MP expressed his view that “the problem is that I do not think that the approach was ever light touch; it was soft touch” and that there was a need to scrutinise the way in which the FSA had fulfilled its role.99

142. Robert Peston described some of the ways in which the FSA’s supervision had been inadequate in his evidence to the Committee—

“The FSA… has admitted that it did not boss the likes of HBOS, Northern Rock and the RBS around enough when they were doing reckless things. Northern Rock should not have been allowed to have become so incredibly dependent on wholesale markets, because that made it a very risky bank, and it should almost certainly not have been allowed to lend all those billions in the form of 100 per cent plus mortgages or, indeed, the 95 per cent mortgage and personal loan package that meant that it was lending up to 125 per cent of a property's value. That sort of bonkers behaviour would have had any sensible regulator saying, "Hang on a second - this does not sound like prudent banking." It is also amazing that HBOS was allowed to become so extraordinarily focused on particular sectors and that regulators simply did not stop all its corporate lending to property and construction.”100

143. In evidence to the Committee, the FSA acknowledged that there had been failings in the way that it fulfilled its supervisory function—

“We have on numerous occasions owned up to the FSA's regulatory failures, particularly post-Northern Rock, and our chairman has pointed out that the regulatory environment and the expectations of the regulator have changed substantially since what happened to Northern Rock in 2007. The regulatory philosophy pre-2007 was fundamentally different from what it is today; indeed, in my opening remarks, I mentioned that we have used our increased resources to increase the intensity and intrusiveness of our supervision. However, it is fair to say - and we have said it ourselves - that regulation was much more light touch before the crisis. The approaches that we took were dictated by the market and the regulatory authorities at the time but, with hindsight and as things have changed, we recognise that some of them are no longer appropriate.”101

144. The Turner Review recognised that there were failings in the coordination of activities between the Tripartite Authorities, which have also been criticised for the ways that they communicated with each other. Robert Peston affirmed this in evidence to the Committee, stating—

“…for a period, part of what was going wrong was that the different bits of the tripartite system were operating too much in their owns silos. As a result, the right kind of market intelligence was not being shared across the piece. It may also have led to a more cumbersome approach to the bank rescues initially, although the shock has meant that the three authorities have been working together much better more recently. It plainly matters that central bankers talk a lot to supervisors if they are to understand what is going on. In good times and bad, there is a tremendous connection between ensuring that banks have the right amount of capital and the sort of stuff that the Bank of England is interested in, such as credit conditions. One thing that went wrong over a period of years was the complete disconnect between monetary policy, which is the Bank of England's role in ensuring sufficient liquidity in the economy, and prudential supervision. The two are inextricably connected, yet the two parts of the system operated as though there was no connection.”102

145. In addition to the inadequacy of the supervisory regime, evidence to the Committee suggested that the financial sector displayed considerable ingenuity in finding ways to bypass the rules. Gillian Tett suggested that technological innovation helped to support banks in this. She stated—

“Over the past century or so, almost every time that regulators or politicians have slapped a set of rules on the industry, a few years later bankers have tried to run rings around them. As they have done so, they have usually created distortions in the system that have in some way paved the way for the next crisis—almost every crisis has been created as a result of a reaction to a previous crisis.103

146. The Committee considers that the evidence that it heard calls into question both the regulation and governance of the financial sector. The Committee’s inquiry has provided evidence of the weakness of remuneration and risk committees in some banks, the pressure from shareholders for profits, chief executives who have been hard to challenge and non-executive directors who have not challenged the senior management of the bank. Checks and balances seemed to be frequently absent, or suppressed to meet the demand for growth. The rare voices that expressed dissent appear to have been hushed by the overwhelming groundswell of belief in the new financial order. To paraphrase Keynes: the banking sector was moved by animal spirits, and not by reason.

The story of the Scotland’s financial institutions

147. The Committee recognises that there were a number of global factors at play, but it believes that this should not detract from assessing the management structures and policies of the two Scottish banks that failed. The evidence from the Clydesdale Bank, while not in itself a bank on the scale of either RBS or HBOS (although it is a subsidiary of the large NAB group), highlighted that the fact that there were banks which resisted the pressure from shareholders for growth and maintained safer banking models. RBS and HBOS were not merely victims of global forces, but rather architects of their own downfall.

The Royal Bank of Scotland

148. Under the leadership of Sir George Mathewson and especially Sir Fred Goodwin, who succeeded him as Chief Executive Officer, RBS had pursued an aggressive policy of acquisition and expansion. This resulted in RBS becoming reliant on the inter-bank market referred to above and exposed to the US sub-prime market. Just before the credit markets collapsed, RBS made what many analysts regard as a ‘step too far’ in buying ABN AMRO’s investment bank at a top of the market price. Despite a massive £12 billion rights issue in May 2009, the combination of funding difficulties, toxic debts and post-acquisition write-downs, led to a further capital injection of £37 billion in October 2008. Virtually all of this came from the UK Government.

149. The evidence that the Committee heard in relation to the downfall of RBS focused on its pursuit of growth and its risk management strategies. John Crompton of UKFI indicated that these were the two areas that UKFI had identified as problematic—

“When we looked into the issues that we felt most needed fixing at the bank, we felt that two major strands had gone awry. First, there was in the organisation a very strong cultural bias not towards value creation for the shareholder, but towards growth more or less irrespective of whether it was valuable. That can probably be seen in its acquisitive history - the way that it sought to grow through acquisition—and a culture in which balance sheet expansion was chased for its own sake.

“On its own, such a risk-enhancing strategy might have been manageable. Hand in hand with that, however, was a thoroughly inadequate risk management structure, in which the processes for making risk decisions were simply not fit for purpose. We feel that those two elements are the primary drivers of the crisis that RBS got itself into. It is absolutely true that RBS's investment banking arm had typified those features over the past few years but, if you go back further into the organisation's past, you will probably see an excessive focus on growth, instead of value creation, without good risk management.”104

150. The expansion of RBS was perceived by witnesses to be unsustainable. Michael Kirkwood of UKFI stated—

“RBS had bulked itself up to having a balance sheet of £2 trillion sterling, which is humungous. Given the capital ratios that are now required or regarded as sensible, that is not a sustainable balance.”105

151. Irmfried Schwimann of the European Commission was also of the same view. She stated—

“Being broad based and being viable are two different things. Part of RBS's problem is that it had a very expansionary policy. Sometimes, its decisions to buy companies in Europe might not have been the wisest. Perhaps its decision to expand away from its core business model into other areas might not have been the wisest decision. Would not it be better to get back to the core of the business, concentrate on that and do what one can do best?”106

152. The acquisition of ABN AMRO was further indicative of this focus on growth. In evidence to the Committee, John McFall MP articulated the Treasury Committee’s view that “the Royal Bank of Scotland was an example of a failure of corporate governance” and that particular failings had been in evidence in RBS’s decision to acquire ABN AMRO—

“When RBS's then chairman, Sir Tom McKillop, appeared before our committee, he was very clear that the demise of RBS commenced with its acquisition of ABN AMRO. After carrying out due diligence in May 2007, RBS acquired ABN AMRO on 15 October, which was after the credit crisis had started with the default of BN Paribas on 9 August. RBS continued with the acquisition despite due diligence having been done six months previously. The acquisition also had the unanimous approval of the RBS board.”107

153. The wider issue of the degree to which boards failed to challenge senior managers of financial institutions prior to the banking crisis has a particular resonance in relation to RBS. John McFall MP identified the lack of challenge coming from non-executive directors and the levels of risk that RBS was exposed to as a key cause of its downfall—

“As I said at the time, any examination of RBS's corporate governance needs to ask whether the non-executive directors were stupid or whether the problem was systemic. Given the track record of the non-execs on the RBS board, who had a distinguished pedigree in the financial services industry, the problem must be systemic. We felt that that was coupled with the issue of risk and product complexity. As I mentioned, I do not think that anyone now has a handle on risk, so the methodology of risk needs to be looked at again.”108

154. Jeremy Peat also questioned the role of RBS’s non-executive board in the run up to the crisis and the implications that its failure had in terms effective governance and oversight—

“Peter Sutherland and the others are highly experienced and well-regarded individuals. Why did they not question what was happening? I do not know. It is clear that the strength of character of at least one individual might have had some influence, but non-executives have significant responsibilities and it was a strong non-executive board. It raises the question of whether that form of governance and shareholder-related oversight can be made to work.”109

155. While the scale of the RBS failure was enormous, only parts of the bank were affected by exposure to toxic assets. The acquisition of ABN AMRO and its ongoing exposure to collateralised debt obligations was a key factor in RBS’s collapse. Jeremy Peat emphasised this to the Committee—

“RBS still has many fine parts. One has to remember that what went wrong was in a limited part. It was a combination of taking on those nasty toxic assets through some particular elements of the institution - largely based in Connecticut - and the purchase of ABN AMRO, which added to that problem at exactly the wrong time.”110

Halifax Bank of Scotland

156. The policies that led to the ruination of RBS were different to those that undermined HBOS. HBOS had pursued an increased share of the property loan market and had lent substantially against housing and commercial property. The weakness of HBOS’s internal risk policies meant that these loans resulted in significant impairments as property values declined. HBOS was also exposed to over £107 billion of loans to the UK corporate sector, with some 23 per cent of its loans and advances (at June 2008), including £66 billion in lending to commercial properties. This strategy left the bank exposed to a decline in collateral values.

157. HBOS had also been very reliant on wholesale money markets, which had become an increasingly expensive and unreliable source of funds as a result of the financial crisis. A drop in its share price prevented HBOS from raising the £4 billion that it had hoped by means of a rights issue in July 2008, although this was underwritten by investment bankers at Morgan Stanley and Dresdner Kleinwort. HBOS subsequently started merger talks with Lloyds TSB. The UK Government take-up of Lloyds TSB and HBOS shares in October 2008 was conditional on the merger, for which competition concerns were controversially waived in light of the “significant benefits to the public interest as it relates to ensuring the stability of the UK financial system”.111

158. The excessive lending strategy pursue by HBOS was evident in the significantly higher (in relative terms compared to its competitors) loans-to-deposit ratio that it held. In June 2008, this stood at 177 per cent, almost fifty percent higher than Lloyds TSB or RBS. This made HBOS very dependent on wholesale markets. Robert Peston observed that HBOS “treated the wholesale markets as permanent sources of funding that could not possible dry up but, as we know, in the summer of 2007, that turned out to be a very misplaced assumption.”112 When liquidity in the wholesale markets became scarce, HBOS required substantial capital injections. This problem was exacerbated by HBOS’s large concentration of UK residential mortgages and its sizeable commercial property portfolio, which made it very vulnerable to falls in property prices and mortgage defaults. Archie Kane – the Group Executive Director of Lloyds Banking Group – described the situation at HBOS shortly before it was acquired by Lloyds TSB—

“HBOS was basically running out of funds. That would have impacted right across all the HBOS businesses. The lack of funds—lack of liquidity—eventually impacts on a bank's capital and on its ability to raise and access capital.”113

159. In evidence to the Committee, Archie Kane stressed that in advance of the takeover of HBOS, Lloyds TSB carried out substantial due diligence—

“We did a huge amount of due diligence before we acquired HBOS. In fact, we did everything that we could legally do as one public company dealing with another public company. We were aware of the problems, particularly in the commercial and corporate lending markets. What we did not predict - very few people did - was the steep and rapid decline of the economy in quarter 4 last year and into this year. When a bank has big lending books, a rapid decline in the economy has an impact on impairments and bad debt provisions. That is the one thing that we probably underestimated. However, we were not alone in forming that view.”114

160. Nevertheless, the scale of the impairments at HBOS was to escalate as the financial crisis deepened and the full scale of its exposure became evident. When questioned by the Committee, Archie Kane confirmed that “It is clear now that HBOS could not have survived on its own. It was finished as an entity.”115

161. As noted in the previous section, HBOS and Lloyds TSB received an injection of £17 billion in October. Archie Kane also confirmed that HBOS – like a number of other banks - had received special liquidity arrangements from the Bank of England towards the end of 2008. He said “for HBOS, that peaked some time in November 2008 and was paid back prior to the acquisition on 19 January—the figure was about £25 billion.”116

Bank of England support to RBS and HBOS under the Emergency Liquidity Assistance scheme and RBS under the Asset Protection Scheme

162. It has subsequently emerged that the Bank of England, in its role as the ‘lender of last resort’, provided both HBOS and RBS with loans totalling some £62 billion (with £25.4 billion going to HBOS) under the Emergency Liquidity Assistance scheme. The justification was that this avoided a run on the banks akin to what had happened to the Northern Rock.

163. By the time that the Committee took evidence from the Royal Bank of Scotland and Lloyds Banking Group in the late autumn of 2009, it had become apparent that the UK Government would take up an option of a further £8 billion in the form of an additional 12,000 million B shares in RBS. The ownership of 51,000 million B shares brought the UK Government’s total shareholding to 84per cent of share capital, although the voting shareholding remained at 70per cent. The UK Government’s shares in RBS and Lloyds Banking Group are managed by UK Financial Investments Ltd (UKFI) on behalf of the Treasury. RBS also entered the Government’s Asset Protection Scheme, which would allow it to protect £282 billion toxic assets. Lloyds Banking Group, although it had initially indicated its intention to enter the Asset Protections Scheme, instead decided to raise capital through a share option and pay the UK Government £2.5 billion for the implicit protection received in the intervening period.

The failure of Scotland’s banks

164. In evidence to the Committee, Robert Peston reflected on whether RBS and HBOS’s “origins within the smaller Scottish economy possibly made them more emotionally open to the notion that there were ways of fuelling expansion other than tapping their domestic deposit base.” He noted that these two banks “became much more dependent on securitisation and wholesale markets than some other institutions did.”117 He also suggested that there might be “a dimension that is peculiar to a smaller economy with people in a particular industry who are particularly talented and have big ambitions.” This was a point that Gillian Tett also considered in evidence to the Committee. She suggested that—

“among the things that drove the Scottish banks to do what they did were - again - a sense of insecurity, a desire to catch up quickly and be big on the global stage, naivety, and the thrill of the glory of suddenly being Mr Big and of thinking that their balance sheets were going to be as big as the entire UK economy, when they were nobody a few years ago. That is a heady and toxic combination that is, as we now know, lethal.118

165. However, this was a position rejected by Archie Kane of Lloyds Banking Group. His interpretation was that the failures in RBS and HBOS were linked to their operating models and that the broader systemic failures that caused the crisis meant that few banks remained immune from the impact of the crisis. Archie Kane stated—

“Sometimes the inference is drawn that there was a problem in Scotland. It is important to say that my view is that the issues that impacted on the two big Scottish banks were more to do with the operating models that the banks used than with anything intrinsic to or endemic in Scotland and the Scottish economy. Banks in virtually every jurisdiction in the world ended up having problems - we could look at Fortis, Commerzbank and ING. Fundamentally, the issue comes down to the operating model that those institutions used.”119

Dunfermline Building Society

166. Another Scottish casualty of the financial crisis was Dunfermline Building Society. The rapid decline of this institution was witnessed at first hand by the Committee. In October 2008, it had taken evidence from the then Dunfermline’s Chief Executive, who had indicated that its “stress testing shows that we have the capital to withstand and ride out what might be classified as the perfect storm.”120 He provided further detail on Dunfermline’s position at that time—

“As is the case with other building societies, more than 75 per cent of our funding comes from retail investors, which helps to make the model robust…The fact that we are well funded by individual investors means that, at the moment, we are not as pressurised in the wholesale markets. To the extent that we have investment from the wholesale markets, there is some pressure on the cost of money, because it is expensive.”121

167. However, events were to prove otherwise and by March 2009 it had become apparent that the Dunfermline could have losses amounting to £26 million for the 2008 financial year. The reasons for Dunfermline’s balance sheet deficits were twofold. One reason was the increasing commercial real estate loans that Dunfermline had committed to between 2004 and 2007 and the other was the purchase of mortgages from other lenders, including buy-to-let mortgages.

168. On 28 March 2009, the FSA determined that Dunfermline Building Society was failing, or was likely to fail, to satisfy the threshold conditions for operating as a deposit taker under the Financial Services and Markets Act 2000; and that it was not reasonably likely that action would be taken by or in respect of Dunfermline that would enable it to satisfy the threshold conditions. Dunfermline was not in the same position as Northern Rock or Bradford & Bingley had been in that the FSA was concerned that its problems related to “possible future solvency under stressed conditions”122 as opposed to immediate cash-flow problems.

169. Events unfolded rapidly and by 30 March 2009 the Bank of England had announced that core parts of Dunfermline Building Society would be transferred to Nationwide Building Society, including Dunfermline’s retail and wholesale deposits, branches, head office and originated residential mortgages (other than social housing loans and related deposits). This followed a sale process conducted by the Bank of England over the weekend of 28-29 March under the Special Resolution Regime provisions of the Banking Act 2009.

170. Thus, within the space of a few days the staff of the Dunfermline, as well as the majority of its operations, were transferred to the Nationwide. The social housing loans of Dunfermline’s customers (and related deposits) amounting to £500 million were transferred temporarily to DBS Bridge Bank Ltd, a ‘bridge bank’ owned and controlled by the Bank of England. The Bank of England stated that this allowed it “to support Dunfermline’s social housing portfolio, consistent with the objectives of the Special Resolution Regime, and provides time to secure a permanent solution.” On 1 July 2009, the Bank of England announced that the social housing book had also been taken over by Nationwide. The remaining Dunfermline business was put into the Building Society Special Administration process and managed by KPMG, which was appointed as the administrator. This included the lower quality loans consisting of commercial loans, acquired residential mortgages, subordinated debt and treasury assets.

171. In evidence to the Committee, Nationwide provided evidence on the total cost to the State of the transfer of Dunfermline. Alison Robb of Nationwide stated—

“The discount that we received during the transaction was £68.5 million against the asset value. That, in effect, was the contribution from the Government.”123

172. The Committee notes that the Scottish Affairs Committee’s report on the Dunfermline Buliding Society concluded that—

“There is a clear difference of opinion between witnesses over whether £20m, £60m or more would have been sufficient to secure Dunfermline Building Society’s long-term future. This is a question that we are not qualified to answer. This was the first time that the Special Resolution Regime was used. Therefore, the Tripartite Authorities should undertake a review of how the Regime operated, and that review should look at the intereaction between the Tripartite Authorities and at the decision making processes.”124

173. The Committee recalls the profound feeling of shock and dismay in Scotland in the autumn of 2008 when our two major banks both failed within a matter of weeks and the UK regulatory system was shown to have failed. The Committee does not believe that the severity of the situation should be underplayed, nor should the potential consequences of not rescuing these banks be forgotten.

174. The Committee notes the number of individual factors that contributed to the complexity of the financial crisis. The eventual scale of the crisis caused by this range of factors was so severe that the Committee considers that the very purpose of banks and their place in society was brought into question. In this context, the Committee concurs with the view of the Governor of the Bank of England that, “having banks that operate on the assumption that they will receive taxpayer support if things go wrong is simply inconsistent with their being in the private sector.”125

175. The Committee considers that the gravity and scale of the financial crisis has had significant implications for the economy and society. It is vital, therefore, that action is taken by the appropriate authorities to develop remedies going forward and prevent it happening again. Just as the causes of the crisis were many, so are the lessons learned. Most important, however, is the need to act to prevent such a crisis occurring again and having such a significant impact at either a state or global level.

lessons learned

The regulatory framework

176. The shape of the regulatory framework that is developed in response to the financial crisis is of profound importance to the financial sector in Scotland in the future. At the time of concluding this inquiry, there is a lack of clarity on the form that regulation will take in the UK pending the result of the general election that must take place before 3 June 2010.

177. However, there have already been a number of steps taken in the UK as a response to the financial crisis. This section looks at the measures taken to tighten up the supervisory regime for financial institutions and the legislation passed relating to financial services. It also considers some of the other responses which will require a cross-border – either European or global – approach.

178. The Committee heard evidence from a wide variety of financial institutions during the course of its inquiry, including banks, building societies, life and insurance companies, investment managers and asset servicing. Whilst there was a general recognition that there was a need for change in the supervisory environment, concerns were also raised about the potential burden of regulation. In some cases, the Committee recognised the legitimacy of these concerns. For example, the traditional building society model generally proved to be safer and more resilient to the effects of the financial crisis. However, the greater prudence that characterised this model also made it more difficult for building societies to compete with banks. The Committee therefore shares the concerns of the Nationwide and credit unions that they are being disadvantaged by the types of capital that are deemed admissible to contribute to Tier 1 capital thresholds. The Committee believes that care needs to be taken in the development of the regulatory regime in order to ensure that the diversity of the financial services sector is reflected and that undue burdens are not placed on the types of institution that proved that their risk policies and systems were more resilient during the financial crisis.

179. In evidence to the Committee, the Cabinet Secretary for Finance and Sustainable Growth emphasised the importance of the outcome of the discussion surrounding future regulatory regimes for Scotland’s financial sector—

“I accept that there are wide questions about financial services regulation, because of the nature of financial services products, instruments and activities. Much financial services activity in Scotland has a global reach. Therefore, the debate on regulation will involve all levels of governance—Scottish, UK, European and global. In that context, we must ensure that we have regulatory arrangements that are appropriate in the structures, conditions and circumstances that emerge. A very active and live debate is under way.”126

180. The importance of drawing on the lessons learned from the crisis and translating them into effective and lasting reform was stressed by the STUC, which expressed a concern that—

“…despite the plethora of consultative activity that has taken place since the banking crisis and the huge amount of political capital that has been expended, we have seen few signs emerging that meaningful reform has taken place or is about to take place. We have seen little progress towards a reformed banking sector, never mind a reformed economic and social model, which we believe is necessary. There appears to have been little appetite to grasp some of the fundamental issues that have emerged from the crisis. For instance, why are financial markets prone to failure, and why are financial professionals able to benefit from the various market failures that exist in the sector and to extract such extravagant rewards? Real reform is essential.”127

181. The Committee considers that the future shape of the regulatory environment will be crucial in the Scottish context. At the time of concluding this report it appeared that RBS and HBOS/LBG still had significant progress to make in restoring their balance sheets. Moreover, given that these two Scottish banks were on the brink of collapse with potentially devastating impacts on the Scottish economy, the Committee believes that it of fundamental importance that the regulatory regime is designed to prevent a crisis of this scale happening in the future.

Regulatory reform and legislative change

182. The Committee considers that sub-prime bubble serves to highlight the lack of realism in the pervasive expectation that property prices would continue to increase and that interest rates would remain low, as well as the assumptions that securitisation would disperse, and not spread, risk. Furthermore, the abandonment of sound lending and risk-assessment principles had saddled individuals with large debts left them bankrupt or homeless. The Committee notes that the “irrational exuberance” surrounding securitised products encouraged those that were developing and trading in them to overlook their complexity and focus on short-term profits. The Committee believes that a major lesson to be learnt from this financial crisis relates to the institutional development of a more sophisticated understanding of risk and the policies and structures that are needed to manage it.

The FSA

183. The FSA was substantially criticised following the financial crisis for its “light-touch” approach, as this report has previously noted. The Turner Review and the supporting FSA Discussion Paper took an in-depth look at the causes of the financial crisis and recommended steps that the international community needed to take to enhance regulatory standards, supervisory approaches and international cooperation and coordination.128

184. In response to the financial crisis, the FSA acted quickly to initiate a more intrusive and systematic approach to supervision in order to develop the policies and structures needed to manage risk. The Supervisory Enhancement Programme was launched in April 2008. This programme involved the allocation of more resources to the supervision of high-impact firms and sectoral and firm comparator analysis and an increase in the frequency of comprehensive risk reviews. The supervisory style of the FSA now focuses on key business outcomes and risks and on the sustainability of business models and strategies. The FSA also conducts a more intensive analysis of information relating to key risks. The Committee notes from the evidence that it took during the course of the inquiry that financial institutions have already undergone more intensive supervision by the FSA, particularly in the form of stress-testing.

185. The FSA’s resources, notably in terms of staff, have been increased since the financial crisis. Jon Pain told the Committee that the FSA had “commenced and completed a substantial hiring of additional resources.”129 The increase consists largely of specialists from the market place who have technical expertise on the range of firms regulated by the FSA. One of the criticisms of the FSA was that it was inadequately staffed and lacked the expertise to understand the levels of risk that some firms were exposed to and the complex financial instruments that they had developed and this additional staffing represents a response to that.

186. The FSA had reinforced its supervisory regime, particularly in relation to stress testing. Firms have been required to improve their stress testing capability, enhance their capital planning stress testing and conduct reverse stress testing, which helps firms understand the factors that could cause their business to fail. The stress testing is deisgned to ensure that risks are sufficiently well-understood and appropriately managed to protect consumers and market confidence.

187. John Pain stressed the importance of understanding that the “inherent business model and strategy of a particular financial institution, because such a level of analysis enables us to understand the risks that are posed to the firm and to the marketplace as a whole.” The FSA, by assessing an institution’s judgements for the future, aims to anticipate some of the risks posed by particular institutions and their strategies and risk models. This approach represents a more intensive form of supervision than that which took place in the past.

188. A number of the issues addressed in the Turner Review related to the need to strengthen the regulatory regime and the capital and liquidity regime globally. This work is being taken forward at an international level and recommendations on the Basel regime are expected later in 2010. Jon Pain stated his expectations in regard to European and global initiatives—

“I believe that, at a European and global level, there will be a higher level of capital required; redefinitions of the type of capital that banks need to provide; and different approaches to resolving problems with banks that get into difficulties, including the introduction of so-called living wills. Such new measures, which we are in the throes of implementing, will make the regulatory regime tighter and more capable of dealing with the outcomes of a crisis.”130

The Tripartite Authorities

189. At a more general level, the Committee calls on the Tripartite Authorities to ensure that there is geographical consistency in the way in which they fulfil their statutory duties. In this context, the Committee notes the evidence from Paul Chisnall of the British Bankers Association, who said that, “if we accept that a strong and robust regulator strengthens financial institutions, when the FSA is increasing its resource to adopt a more intrusive approach to supervision - with the industry's support - there is the question of whether it is devoting sufficient local resource to activity in Scotland.”131 While no evidence emerged from the Committee’s inquiry to suggest that there were any specific underlying regulatory failures in relation to the British banks that failed, the Committee notes that all of these banks were located outside of London. The Committee suggests that the Tripartite Authorities, particularly the FSA, should assess the consistency of their geographical engagement and how they engage with the Scottish Government as they assume a stronger role in the regulation and supervision of the financial sector going forward.

Legislation

190. At the time of concluding this inquiry, the Financial Services Bill was being considered by the House of Lords. This Bill is the third piece of financial services legislation since 2007 to respond to the banking and financial crisis. It seeks to address the criticisms that the Tripartite Authorities had not been sufficiently coordinated in fulfilling their respective roles prior to the financial crisis by creating a Council for Financial Stability to co-ordinate the Bank of England, FSA and HM Treasury with respect to financial stability matters. It also tackles the problems relating to resolution regimes that emerged from the crisis by placing a duty on the FSA to make “living wills”, that is rules requiring financial institutions to create and maintain recovery and resolution plans in the event that they become financially vulnerable. The Bill also addresses the concerns over remuneration policy by requiring the FSA to make general rules about remuneration policies of regulated firms and by extending the company law disclosure regime to include executive remuneration reports.

191. The Financial Services Bill gives the FSA greater authority and responsibilities. This includes a wider authority to prohibit short selling, a requirement for the FSA to work in international fora to develop international standards of regulation and supervision and the provision of the power of information gathering and punishment. The Committee considers that this legislation will help provide the FSA with some of the powers it needs to improve its supervisory regime, but that the development of these powers will be crucial to making the supervisory regime more effective.

A global approach

192. A key lesson learned from the financial crisis has been the need for global solutions. Irmfried Schwimann of the European Commission expressed the view that the global engagement on financial regulation that had resulted from the financial crisis was a positive outcome—

“One positive aspect of the crisis has been the fact that, for the first time, there has been some co-ordination and discussion of the issues at G20 level, which has not happened before. The discussions that are taking place in Europe on a more co-ordinated approach or more co-ordinated supervision would not have been possible before the crisis. Although we always think that the process does not go quickly enough, we have made some headway. Although what is happening in the G20 is not going as far or as quickly as we would all hope - it never does - at least the countries are talking and there is some co-ordination of what we think that the future financial services world should look like.”132

193. The Committee is aware that there are differences of view within the Tripartite Authorities, notably between the Governor of the Bank of England and the Treasury on the “too important to fail” issue, but also on regulatory reform more generally. The Committee welcomes the commitment made by the G20 states to ensure that their domestic regulatory systems are strong as part of the G20 Global Plan for Recovery and Reform agreed at the beginning of April 2009. It considers that the establishment of a new Financial Stability Board with a strengthened mandate will provide a structure for taking a more coordinated global approach to regulation and oversight, which the global crisis demonstrated to be crucial.

194. The evidence collected by the Committee recognised the need for a cross-border approach in key areas to prevent the risk of regulatory arbitrage, whereby a financial institution would relocate to another jurisdiction with a more attractive regulatory regime. Steve Smit, of State Street, explained the importance of consistency across jurisdictions—

“Consistency and harmonisation of regulation are incredibly important. Companies that operate globally and have choices about where they locate their operations would prefer to be treated consistently wherever they operate. In the interests of maintaining a level playing field, regulation needs to be consistent; otherwise there will be a risk of regulatory arbitrage, with companies choosing to locate operations where they see the most conducive regulatory and legislative environment. A danger exists, and I would encourage the appropriate bodies in jurisdictions to come up with a consistent framework and approach.”133

195. The Committee has also said previously that it has sympathy with reforms that would prevent one failing bank from bringing down a country's financial infrastructure and from spreading contagion to the rest of the world. We believe that more effective resolution regimes for failed banks, restrictions on banks from utilising retail deposits and reserves to fund their more risky activities and stronger capital buffers are essential to achieve these aims. The Committee notes the importance attached by Stephen Hester to the importance of “living wills” in light of the experience of RBS—

“I refer to the debate around living wills, as it is perhaps called. The world must try to move to a position in which it is unnecessary for state intervention in banking crises to be on the scale that we have just witnessed. Banks must be able to function through crises and, if there are losses to be taken, they must be able to take them without such a level of public support. It is complicated, but it is an important systemic issue with which to grapple and on which to make progress.”134

196. Whilst the Committee believes that it is a fundamental premise that large and more important banks with a global presence must be made safer, it also calls for consideration to be given to the legal structure of banks and where they and their subsidiaries are incorporated. The Committee notes that Banco Santander SA, which was incorporated in 1875 in Spain, has subsidiaries that are incorporated in other countries. For example, Santander BanCorp is incorporated under the laws of the Commonwealth of Puerto Rico and the company and its banking subsidiary are subject to federal and Puerto Rico banking regulations that impose restrictions on and provide for general regulatory oversight of the Corporation and its operations.

197. The Committee considers that this type of structure has the potential to help disperse the risks associated with the collapse of a global bank or one arm or subsidiary of it. For us, it is not necessarily that size is the key issue but more that the legal structures of a globally-connected bank are designed in a way that when it fails, it can be wound down in a sensible manner without any losses being spread to countries beyond the borders of one particular national subsidiary of a bank.

198. The Committee is of the view that a key conclusion that has emerged from its inquiry is that global solutions are necessary to address the globalised operations that banks are engaged in and their global presence. As evidenced elsewhere in this report in relation to Iceland, the potential risk to a country of the failure of one or more global banks incorporated and headquartered in its territory is huge, especially when the size of the bank’s balance sheet is equivalent to a significant proportion of the country’s GDP. It is therefore vital that progress continues to be made at the G20 level on these global issues.

Global imbalances

199. Global imbalances have been identified as a key cause of the financial crisis. The imbalances in debt between east and west exacerbated the crisis. China, Japan and a number of wealthy-oil producing countries had developed large current account surpluses while the US. UK and some Eurozone counties had developed substantial current account deficits. The Committee notes that as a result of the financial crisis, these global imbalances have increased yet further. Western countries seeking to raise capital have become further indebted as they seek sovereign purchasers with current account surpluses to buy government securities. The financial crisis and subsequent economic recession has served to increase both the national debts of many western nations and the proportion of that debt that held by other countries, most notably China. If, as many commentators have emphasised, global imbalances were a key factor in the current crisis, the Committee is of the view that this issue has not yet been addressed sufficiently by those western governments with large sovereign debts and that it should be a key objective of Western government to reduce their deficits if we are not to be storing up more problems for the future.

Remuneration

200. In response to one of the more emotive issues that the Committee encountered during its inquiry – the remuneration of highly paid banking officials – the Committee notes that the 2009 Pre-Budget Report increased the tax on bankers’ bonuses of more than £25,000 to 50 per cent for the period 2009-10 until the 50 per cent tax rate is introduced for earnings of over £150,000.

201. The FSA also integrated the oversight of remuneration policies into its overall assessment of risk. Remuneration, particularly in terms of high bonuses and the link between these and excessive risk taking, was identified by the FSA as a factor - but not a key cause - in the financial crisis. The FSA developed a code which it anticipated taking effect from the beginning of 2010, although the FSA indicated in evidence to the Committee that it expected bonuses paid in respect of 2009 to be subject to this code on remuneration practices. In evidence to the Committee, Jon Pain stated that the purpose of the code was “to ensure an appropriate balance between risk and bonuses”135 rather than regulating the amount that should be paid—

“The aim is to ensure that the risk management within a firm, as reflected in its remuneration code, is acceptable and that the appropriate checks and balances are in place in that regard. Our code is not about setting an absolute maximum in respect of institutions, save for one important exception: as a regulator, we expect the institution to ensure that it has adequate capital on a forward-looking basis to meet our requirements following the impact of the distribution of dividends or bonuses. If an institution was to put its capital position at risk by overdistributing either bonuses or dividends, we would take a keen interest in correcting that. However, we are not a regulator of the quantum of bonuses.” 136

202. The FSA indicated that for action to be effective on limiting the high amounts paid in bonuses, there would be a need for global coordination given the global character of many banks. Jon Pain indicated that the FSA expected there to be “co-ordination across the globe, particularly across Europe, on a standardisation of remuneration policies.”

203. Others witnesses that gave evidence to the Committee perceived the issue of remuneration to be critical to addressing the risk culture within banks and their role in the economy and society more broadly. The Rt. Hon John McFall MP commented that, “the remuneration issue is about the long-term interests and health of the company and society, and it is therefore hugely important.”137 The view of the Governor of the Bank of England, Mervyn King, in a speech in Edinburgh highlighted the way in which remuneration could distort the allocation of risk—

“It is hard to see how the existence of institutions that are “too important to fail” is consistent with their being in the private sector. Encouraging banks to take risks that result in large dividends and remuneration payouts when things go well, and losses when they don’t, distorts the allocation or resources and management of risk. That is what economists mean by “moral hazard”. The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The “too important to fail” problem is too important to ignore.”138

204. In evidence to the Committee, Irmfried Schwimann of the European Commission, commented on the difference in perspective between Europe and the US and indicated that any initiatives taken at the European level would be through corporate governance—

“There is also clearly a difference of opinion as far as bonuses are concerned, with a distinction being drawn between the central European approach and the US approach. Sometimes I wonder whether that is not a little artificial, because people should be paid well for what they do well—the problem is that they have been paid well for what they have not done well. We need to look at incentive remuneration structures that favour longer-term policy in companies, rather than the short-term bonus culture that we had previously. We will not tackle the issue using competition instruments; it might be tackled through company law, corporate governance and so on. A lot of work is being done in the area.”

205. Evidence to the Committee from Unite the Union and the Association of British Insurers (ABI) highlighted the considerable differences in remuneration policies in different parts of the financial sector and the crucial role that bonuses played in providing lower-paid workers with adequate salaries. Maggie Craig warned against the assumption that all of those working in the financial sector benefited from large bonuses—

“I get slightly alarmed when there is talk about people in financial services all earning lots of money and getting huge bonuses. A lot of people who are sitting in Standard Life house or out at the Gyle, or working for Scottish Widows, earn £15,000, £18,000 or £20,000 a year and get bonuses of 8 or 10 per cent. That is not the same thing at all, and we forget that at our peril. It is very unfair that the whole industry gets tarnished with an image of huge bonuses.139

206. Rob MacGregor of Unite the Union pointed out that average cashier in a bank branch in Scotland earns about £13,500 to £14,000 a year, with the potential to increase that by ten per cent through variable pay. He therefore stressed the need to differentiate between the various areas of banking and to understand that bonuses for the lower-paid were actually part of a variable pay system—

“In general, people do not differentiate between retail and investment banking or between the cashiers and clerks who work in bank branches and the investment bankers who work in places like Canary Wharf. People feel that the banking sector is overpopulated by the greedy, the incompetent and the corrupt. As I said, our problem is that the public perceive that cashiers and clerks in bank branches are on fantastic salaries and have bonuses on top of that with which to buy the second home and the Ferrari, which is absolute nonsense. Over the past 10 years, basic pay for retail staff has been significantly pegged back through the application of performance-related pay and other similar systems. I say that as a trade unionist; it could be described as a self-criticism of trade unions. Cashiers and clerks have to participate in schemes that are called bonuses but are simply part of a variable pay system. Those bonuses do not go on fancy holidays but are used to make ends meet.”140

207. The Committee also heard evidence from other parts of the financial sector where there was a closer link between long-term performance and remuneration as opposed to a systematic allocation of bonuses on an annual basis. Stuart Paul indicated that the approach to remuneration in his company was one in which “90 per cent of the variable bonus structure is based on three and five-year investment returns”141 The Committee considers that some banks could learn from practices such as these were the bonus system is more closely linked with the financial institution’s performance over a period of time and therefore acts as a disincentive to short-term risk and as an incentive to sustainable profits.

208. The Committee recognises that the issue of remuneration will be an ongoing one that requires a global approach to address it properly. It recognises that for many of the lower paid employees working in the financial sector, bonuses represent an important part of a living wage. However, the Committee also recognises that existing bonus systems are used to encourage aggressive marketing which can be to the detriment of both employees and consumers. Furthermore, at higher levels, bonuses encourage excessive risk-taking for short-term gain.

209. The Committee is of the view that at a time when it is critical for banks to build up their capital reserves it is not responsible for those banks to award large bonuses. It therefore deplores the award of millions of pounds in bonuses at a time when the real economy is only just emerging from a recession precipitated by the banking crisis.

Corporate governance

210. Elsewhere in this report the Committee has identified the problems associated with poor corporate governance, particularly the failure of non-executive boards in challenging senior management and considering risk adequately. This has been identified as a particular failing in relation to RBS before the financial crisis. The key response to the problems linked to corporate governance in the financial crisis was the establishment of the Walker Review.

211. The final report of the Walker Review of Corporate Governance in the UK, was published in November 2009, and recommended overhauling the boards of banks and other financial institutions by strengthening the role of non-executives and giving them responsibilities to monitor risk and remuneration. It also recommended placing a stewardship duty on institutional shareholders to ensure that they play a more active role in the ownership of a business. The FSA will have the responsibility for implementing the recommendations.

212. David Nish, the Group Chief Executive of Standard Life, stated that governance was the area that he would most like to see improved as a result of the financial crisis. He particularly emphasised the importance of non-executive boards dealing with risk—

“It is important that the risk agenda picks up on the appetite for risk, which boards often have difficulty dealing with. It is easy to think of all the positive aspects of business decisions, but it is difficult to challenge yourself to think of the negative aspects—the cost of failure and the willingness to fail. One thing that we should not do with governance is drive out the willingness to take risk, because without risk there is no reward. However, you have to have a clear understanding of the risk that you run and you need the capacity in your business to absorb it. That means either that you have available the capital liquidity to use or you have the action plans in place—the mitigants—either through hedging or through having the resources to be able to do it.”142

213. The Committee welcomes the recommendations of the Walker Review as a first step in the right direction and notes the role taken by UKFI in renewing the boards of the two banks in which it is a major shareholder. However, the Committee remains very disappointed by the lack of significant progress made in addressing the weakness of the role of non-executive directors. The Committee urges the FSA to use its new powers to implement the recommendations of the Walker Review. The Committee is clear that the role of non-executive directors is crucial and that it is important to ensure that that non-executive directors have the right skills, that they can manage risk effectively and that they can challenge the senior management of the institution concerned.

A return to safer banking

214. The ‘originate and hold’ model that was at the core of banking until the late twentieth century resonates with the traditional image of “safe” Scottish banks and “dour” Scottish bank managers. The Committee laments the transition away from the ‘originate and hold’ model and the sounder risk principles associated with it. The Committee would welcome the provision of institutional support for banks, building societies, credit unions and mutuals that employ ‘originate and hold’ models. The reputation of Scottish banks throughout the world was built, in part, on the reputation for sound judgment in its banking community. The Committee considers that there is a need to encourage our banks to return to the fundamentally Scottish principles of financial rectitude at the heart of the ‘originate and hold’ model and banish the irresponsibility and naked greed that fuelled inappropriate financial innovation.

Culture

215. Some of the evidence heard by the Committee warned against over-regulation. Jeremy Peat stated, “you have to get the environment correct and the context right, then you can regulate at the margins.”143

216. Complex and detailed regulation was perceived as potentially expensive in the retail sector, with much of the cost ultimately falling to consumers. Angus Tulloch stated that “anyone in the retail sector will tell you that the amount of box ticking that goes on is incredible. It is becoming very expensive and the consumer pays for it in the end.”144 Angus Tulloch suggested, instead, that—

“Regulation must focus on the spirit, rather than the letter, of the law. A lot could be done through trying to reprofessionalise the industry to ensure that people behave by genuinely looking after the client and putting their interests first. I …have suggested that if everyone in the industry had to take a sort of Hippocratic oath, saying that they would put the clients' interests first and placing themselves under a professional obligation to consider the longer term, that might have a much bigger impact in the long run than ticking the right box.”145

217. While the Committee considers that regulation is important to prevent a repeat of the financial crisis, it also recognises that a change in the dominant culture and an improvement in professional standards is important to reinforce probity and integrity in the financial sector.

Consumer confidence

218. One perspective that the Committee feels is sometimes lost in analyses of the financial crisis and its impact is that of the consumer. The Committee considers that the evidence provided by David Nish on the loss of consumer confidence, and its impact on investment, should be salutary. A key lesson from the financial crisis has been the loss of confidence among consumers not just in the banks, but in the financial sector more generally after the financial crisis. David Nish explained the impact that the financial crisis had on the willingness of customers to invest at the end of 2008 and the beginning of 2009—

“There is no doubt that, during the early part of last year [2009], and probably the last quarter of 2008, customers became very scared and worried about investing activity. They were therefore always trying to seek the lowest-risk asset classes. As you would expect—obviously, the fact that markets in effect fell through reflects a shortage of money going into markets—customers were more interested in cash-related products. They were deferring making investments into pension schemes and so on and were tending to hold on to funds.”146

219. Research carried for the consumer organisation Which? in September 2009 demonstrates the lack of consumer confidence more broadly in the banking sector. The figure below shows the results of a Which? survey into how consumers feel about banks.147

Figure number 7

220. The Committee considers that the Which? survey and the temporary fall in consumer confidence identified by David Nish show that there are important lessons to be learnt by the banks.

Institutional shareholders

221. Institutional shareholders were the focus of considerable criticism for their role prior to the crisis. Given the evidence that the Committee has heard concerning the lack of rigour demonstrated by institutional investors in challenging the companies which they have shares in, the Committee understands the Treasury Committee’s description of institutional investors as “supine and ineffective”. However, the Committee has heard evidence from Standard Life and the Association of British Insurers (ABI) which indicated that firms were beginning to take a more demanding position in relation to the institutions that they held shares in and that ABI was developing a code to promote standards of engagement for shareholders. Maggie Craig set out the progress that her organisation had made with others in developing this code to improve the engagement of institutional shareholders—

“We have brought together the main big trade associations representing the institutional shareholders: the ABI, the Investment Management Association and the National Association of Pension Funds. We are putting together a code that will enable institutional shareholders to see what best practice is in corporate governance, remuneration and shareholder engagement. The institutional shareholders would be invited to join up and comply with the code, which is to be overseen by the Financial Reporting Council. We are working on the details of how the code would operate and how the FRC would oversee it. There is therefore acknowledgement that we must do more and that there must be better ways of getting traction and bringing institutional shareholders together so that they can coalesce—that is the start of our work.”148

222. The Committee calls on public sector pension funds and other institutional investors to adopt a more active role in fulfilling their duties and responsibilities as institutional shareholders.

European legislation

223. The European Commission has developed regulations concerning the insurance and investment management sectors as part of its competencies in relation to the single market. During the course of its inquiry, the Committee heard concerns from both individual firms and representative bodies notably about the development of the Solvency II Directive and the Alternative Investment Fund Managers Directive. The harmonisation of solvency rules aims to ensure that insurers and reinsurers all meet minimum requirements relating to the amount of financial resources that they have to cover the risks to which they are exposed. The Alternative Investment Fund Managers Directive aims to improve Member State macro-prudential oversight of the sector and enhance the transparency of the activities of Alternative Investment Fund Managers and the funds they manage for investors and public authorities.

224. While the evidence to the Committee affirmed the importance of cross-border legislation in these areas of financial regulation to reduce the risk of regulatory arbitrage, the Committee heard a clear message that there was a need for greater granularity in European regulation as “one-size did not fit all”. The Committee noted that the Cabinet Secretary for Finance and Sustainable Growth had been active on raising issues of concern to investment managers in Scotland and urges the Scottish Government to engage with the UK authorities systematically at the early stages of the development of European Union legislation, as well as on the transposition of European directives by the UK Parliament.

Conclusion

225. The Committee notes the progress that the process of regulatory reform has begun, drawing on the lessons learned as a result of the crisis. However, there are clearly areas where progress is lacking or still needed.

Scotland’s financial services sector in 2010 and the effect of the crisis on the real economy.

Scotland’s experience and its financial services sector in 2010

226. The Committee recognises the importance of the financial services sector to the Scottish economy in the years before the financial crisis. It recognises that the financial sector in Scotland was diverse and had many strengths. Yet the growth of the financial services sector in the UK, and more particularly in Scotland, coincided with the decline in the manufacturing base. Although the Committee recognises the wealth that the financial services sector generated, it is of the view that the impact of the financial crisis has been exacerbated by the increasing preponderance of financial services. The Committee believes that a key lesson of the financial crisis is the value of a more diversified economy, in which the rest of the economy is not rendered economically vulnerable by systemic risk in the financial sector.

227. The Committee considers that whilst the financial sector exhibited many positive aspects in the years preceding the financial crisis, it is nevertheless important to highlight some of the problems caused by consolidation in the banking and building society sector. Although it was clearly of value to the Scottish economy that the two largest banks had resisted takeover bids and had instead grown through acquisition, this also acted to consolidate their national position and reinforce the lack of competition in key areas of the banking sector in Scotland. The lack of competition was further exacerbated by the difficulties encountered by smaller institutions in retaining their independence. Whereas the banking sector in other parts of the UK benefited from a larger number of players, Scotland was dominated by the Royal Bank of Scotland and the Bank of Scotland. These two banks effectively had a duopoly which dominated the Scottish high street and made it more difficult for other institutions to enter the market, hold their own or grow market share.

228. The Committee notes that regulation of the banking sector was reserved to Westminster. As the banks grew, this meant that Scotland was heavily reliant on London-based institutions for supervision of its key industry. The FSA, whilst rejecting the characterisation that its supervisory approach prior to the crisis was “light-touch”, has accepted that its philosophy in the years prior to the financial crisis was based on the belief that markets were self-correcting, that the primary responsibility for managing risks lay with the senior management and boards of the individual firms. This philosophy reflected a wider faith in free-market economics among the Tripartite Authorities and the financial sector itself.149

229. These beliefs are now known to have been flawed and the failure of regulators to exercise appropriate control over one of Scotland’s key industries should serve as a reminder to future governments of the need to maintain an intimate dialogue with the regulators.

230. The Committee heard evidence of the lack of rigour in the risk management policies of Scotland’s major banks in relation to lending as well as their aggressive pursuit of market share and growth. The Committee posits that this was to prove detrimental to businesses and consumers as they became financially over-extended and more exposed to any increases in interest rates or a reduced supply of credit within the banks. The Committee believes that it is important that proposed governance reforms in the banking and other sectors are implemented to prevent a recurrence of problems linked to poor governance.

The financial crisis and its impact on bank lending

231. As noted earlier in this report, the withdrawal of foreign lenders as the financial crisis hit the UK had a detrimental effect on the availability of credit. Robert Peston emphasised that the withdrawal of the Irish banks, the retrenchment of the American banks and the disappearance of the Icelandic banks had a profound effect on the availability of credit. He observed that “the Treasury had calculated that, simply as a result of the withdrawal of credit from overseas and the collapse of many specialist vehicles, something like 50 per cent of lending capacity was taken out of the UK market.”150 This resulted in UK businesses and consumers becoming dependent on indigenous banks.

232. However, the indigenous banks in the UK were not in a position to expand their lending to fulfil the gap left by the withdrawal of foreign lenders in late 2008 and early 2009. The supply of credit and interbank lending had dried up. Although the Bank of England’s Monetary Policy Committee reduced interest rates substantially since October 2008, and interest rates have remained at 0.5 per cent since March 2009, the London Inter-Bank Offered Rate (LIBOR) was as much as 130 basis points higher at the peak of the credit crunch due to the liquidity crisis. The quantitative easing policy pursued by the Bank of England has been effective in reducing this gap to just over 10 basis points which is now comparable with the situation before the financial crisis. However, the higher LIBOR rates and the increased cost of risk made credit more expensive when the UK first entered recession. Robert Peston, in evidence to the Committee in September 2009, stated that “given the enormous amount of capital that taxpayers have put into the big banks and the enormous amount of pressure that politicians have put on the banks, the RBS, Lloyds TSB, HSBC and Barclays are probably making a bit more credit available than they were a year ago.”151

233. As a result of the financial crisis, a number of banks have reviewed their risk management structures and policies and their balance sheets and are now holding more capital to satisfy the requirements of the FSA. As noted earlier in this report, both macro and micro risk management policies at a number of banks made them particularly vulnerable to large-scale impairments as the sub-prime problem emerged and interbank lending and liquidity dried up. Banks have, as a result, reduced their dependence on wholesale markets and are keeping their lending ratios more in line with their customer deposits. HBOS was one of the key banks that weakened its risk policies in order to attract borrowing. Since its takeover of HBOS, Lloyds Banking Group has applied its own risk policies to the bank. Archie Kane stated that “right from the start of our involvement with HBOS, we have applied our risk models and our risk appetite - the areas and types of business with which we will operate.”152

234. The Bank of England has tried to ensure that the supply of credit is not compromised by pursuing a policy of quantitative easing and by reaching agreements with the two banks that the UK taxpayer has major shareholdings in – LBG and RBS – to achieve certain lending targets. Paul Chisnall of the British Bankers Association noted that “that quantitative easing has had a real effect in making good the shortfall that would otherwise have existed as a result of the difficulties with banks' balance sheets.”153

235. The banks that benefited from the UK Government’s recapitalisation scheme – namely RBS and LBG - made a number of commitment to the UK Government, including:

  • maintaining, over the next three years, the availability and active marketing of competitively-priced lending to homeowners and to small businesses at 2007 levels
  • support for schemes to help people struggling with mortgage payments to stay in their homes, and to support the expansion of financial capability initiatives .154

236. There is also evidence to suggest that both businesses and individual customers are being more cautious about their own exposure to debt following the financial crisis and recession. Robert Peston commented—

“I know from my experience with business that there are a number of businesses that, for a variety of reasons, want to repay debt, and some of that reduction in credit is a result of companies voluntarily and rationally deciding that in this difficult period they have too much debt, they want less and they would rather finance themselves in other ways. Some are lucky to be big enough to raise capital from the bond market, equity and so on, while others have simply decided to retrench for a bit.”

Business lending

237. The Scottish economy is dominated by SMEs, which make up 99 per cent of all businesses and employ over one million people. The “SME Access to Finance” survey carried out by the Scottish Government aimed to assess the impact of the financial crisis on this sector. One of the key conclusions was that the type of lending that businesses were seeking had changed with them “seeking short-term capital rather than longer-term capital or investment.”155 Dr Andrew Goudie, chief economist to the Scottish Government, noted that—

“…the demand for credit had in fact increased during the period from 2007 to 2009. Interestingly, the emphasis had moved away from the purchase of fixed assets or credit for emergency purposes, and much more towards the financing of working capital and cash-flow requirements... Another aspect is that, unsurprisingly, the cost of finance to all firms increased substantially during that period, which is very much in line with the other evidence that we examined.”156

238. However, just as more enterprises were looking for credit, the rejection rate from banks increased. Dr Andrew Goudie observed that “what has changed during the recession is that there is a quite striking drop - from about 69 per cent to about 50 per cent - in the number of firms that got 100 per cent of what they asked for.” This decline in approvals for credit was matched by a concomitant increase in rejection rated. Microbusinesses were among the hardest hit. The survey showed that approval rates for microbusinesses fell from about 82 per cent in 2007 to about 60 per cent in 2009. The rates for small businesses fell from about 93 per cent to about 79 per cent, and the rates for medium-sized businesses, which are the slightly bigger companies in the sample, fell from almost 100 per cent to about 89 per cent.157

239. Dr Andrew Goudie also indicated that while lending overall was perceived as more risky, there were a number of sectors that were clearly perceived to be more risky by banks, notably hotels and restaurants, the wholesale and retail sectors, construction and manufacturing.

240. The Scottish Government also considered that the reduction of the availability of credit in Scotland as being attributable to the changes in risk policies and the need for banks to restore their balance sheets—

“Over the past year or more, two crucial things have happened, the first of which is the very substantial change in the risk assessment of banks and, indeed, borrowers. When a huge change in risk assessment is made, one expects lending rates to rise to a certain extent.

“Secondly, the banking system is in a very different situation. It could be argued that, at the moment, banks are very much focusing their attention on realigning their balance sheets rather than on extending their businesses, which I suppose has more to do with sustainability and survivability than with market growth.158

241. The situation faced by SMEs in accessing credit has also been evident in surveys carried out by their trade bodies and in evidence that the Committee heard from the accountancy profession. Iain Coke of the Institute of Chartered Accountants in England and Wales said that among its members, there had been some evidence of banks repricing credit and that “some people have not wanted to raise issues with their banks because of their fear that terms would be reduced or taken away, or would be less favourable.”159 In an informal meeting held with a number of SMEs in Scotland, the Committee heard examples of significant increased in the cost of lending as loans were renewed and of businesses being required to convert loans to overdrafts. Evidence from Fife Chamber of Commerce indicated that banks were charging arrangement fees that were between 50 and 100 per cent higher than previously and that interest could be charges at up to 7 points above the base rate.160 Richard Martin of the Association of Chartered Certified Accountants said that a survey conducted for them by the Open University Business School reported greater costs in borrowing and provided evidence of a “a distinct drop of around 10 per cent in the facilities that were available in the early part of 2009” although there had been some recovery from that position since then.161

242. It was also noted in evidence that the easier lending terms that were in evidence in the years immediately preceding the financial crisis served to highlight the contrast in lending practices since the financial crisis. Bruce Cartwright of the Institute of Chartered Accountants of Scotland suggested that “perhaps money was too easy to get.” He observed that “some people are saying that things are difficult, but that is because fundamentals are being applied that people were perhaps a bit lazy in applying previously.”162

243. The Committee questioned RBS about its provision of lending in Scotland both to business and to those seeking mortgages. Stephen Hester recognised that “the concept was always to incentivise domestic banks through the leverage of state support”163 and explained RBS’s lending position in the following terms—

“In aggregate, we are lending to exactly the same proportion of people who ask us for money as we were before. Eighty-five per cent of all businesses that ask us for money get it, and 90 per cent of mortgage applications are granted. Those percentages are the same as before, but some of the people who are asking us for money are in a worse condition than before, so we must work harder to find a way to get them money while protecting our position - by arranging covenants or extra security, for example. That is simply a function of a recession weakening companies and us having a duty not to lend to people who will not pay us back. You can understand the stress around that.”164

244. In relation more specifically to the delivery of its commitments in Scotland, Andrew McLaughlin of RBS confirmed that—

“In mortgages, we had a commitment of £9 billion and said that £1.7 billion of that would be allocated through our regional funds to Scotland. As of the end of September, we had lent £1.5 billion of that £1.7 billion, so we are very much on track on mortgages in Scotland, and the situation is the same at a UK level. In the case of business lending, our lending year to date in Scotland is up about £120 million, which is a couple of per cent—as Stephen Hester says, that is, broadly, flat. That is because people are repaying loans as quickly as others are drawing down new money.”165

245. Lloyds Banking Group also indicated in evidence to the Committee that it was committed to providing mortgage lending and lending to businesses. Archie Kane emphasised that due to the credit problems faced by HBOS in 2008, it had largely withdrawn from the lending market but that since the merger with Lloyds TSB this position had been reversed. He stated that Lloyds TSB Scotland had increased its lending to the SME sector “by somewhere in the range of 15 to 18 per cent year on year.”166 Lending by the Bank of Scotland declined during that period but from June 2009 it had come back on line.

246. Lloyds Banking Group made a commitment to the UK Government to provide £14 billion per annum: £11 billion to the commercial sector and £3 billion to the mortgage market. While there had been sufficient demand in the mortgage sector, the demand in the corporate sector had not proved to be “as robust as it was in previous times.” 167 Archie Kane confirmed the proportion of loans that were approved—

“We continue to have application conversion rates that are slightly in excess of 80 per cent. The figure varies, but it has not dropped below 80 per cent. We have definitely seen a drop in demand—that is, in the applications that we have received. There has probably been a year-on-year drop in demand of around 20 per cent. “168

247. Archie Kane emphasised that LBG had written to all of its SME customers to indicate the business services that it had available as “the Bank of Scotland has gone through that difficult period, a number of customers might have formed the view that it was not really interested in participating in that market.”169 He also stressed that LBG had to lend within an appropriate risk framework—

“Let me be clear: there are sectors, and businesses within sectors, that might not meet the appropriate credit criteria, so there will be cases that we turn down. At the end of the day, banks want their clients to succeed and survive. Banks lend money with the full intention of getting it back one day. There will be businesses that do not meet the criteria because of their operating model or risk structure. It is important to understand that and to be realistic about it. The intention of Lloyds Banking Group, particularly through the Bank of Scotland, which we are trying to breathe life back into, is to make it clear that we are open for business and that, in the corporate and SME market in particular, we are keen to do business with our existing customers and with new customers.”170

248. The Committee received more encouraging evidence from other banks that were lending in Scotland, notably from HSBC, the Clydesdale Bank and Barclays. These banks had increased their lending in the corporate and business sector, notwithstanding the financial crisis and the economic recession.

249. Clydesdale Bank, as the third largest bank in Scotland, indicated that its market share of business banking in Scotland was around 18 to 20 per cent. Clydesdale Bank emerged relatively unscathed from the financial crisis as a result of its safer business model. David Thorburn, the Executive Director and Chief Operating Officer, noted that the financial crisis had provided opportunities for the Clydesdale Bank, particularly in regard to business banking—

“Strangely enough, there is an opportunity in this crisis for Clydesdale Bank. We are already taking advantage of it and I imagine that we will continue to have that opportunity for some years to come. It applies particularly to business banking, to services for SMEs and to the corporate space. Clydesdale has been able to stay open for business—basically, it has not changed its lending policies through this whole crisis.”171

250. Clydesdale Bank indicated that it had provided £2 billion of new lending to business in the previous year, as well as support through its business centres. David Thorburn explained that in 2004, the Clydesdale Bank had taken a decision to decentralise credit decision-making to local centres and branches and that around 90 percent of decisions were taken by credit managers based in local centres. He identified this as being one of the reasons why Clydesdale’s bad debt had been less than that of most other financial institutions. He explained that—

“The idea was to bring the centres closer to the business community, so the credit person could meet customers and professional advisers. We implemented that for selfish reasons, because such a service had disappeared in banking, and it made Clydesdale Bank different if we operated in that way. We hoped that that would be more attractive and allow us to do more business. As it turned out, that struck a chord in communities, which persists to this day.”172

251. HSBC confirmed in evidence to the Committee that it was committed to expanding its business lending. It stated that its current market share of small business lending was in the region of two per cent in Scotland, while its share of mid-corporate business was between five and ten per cent. However, John Rendall, the HSBC Chief Executive Officer in Scotland, expressed the aim to grow HSBC’s market share by two to three times within five years. He also indicated that those shares were growing and that HSBC’s rate of growth was accelerating.

252. John Rendall stated that HSBC had increased its lending to businesses in Scotland by 32 per cent in the first half of 2009. However, it had surveyed growth businesses in the UK and found that, “Although 32 per cent of the growth businesses in the sample that the report used said that they believed that accessing finance was going to be an important element in their ability to achieve their growth plans, only 15 per cent were actually able to access finance.” HSBC therefore expressed a concern that there was “a slowness about the shift from the defensive, recessionary mindset to a more opportunity-minded, recovery mindset.”173 While HSBC had lent half of a £1 billion fund to provide new facilities to SMEs in the UK in 2009, it had also found that a comparable figure had been repaid by other SME customers.174

253. John Rendall recognised the role that HSBC could play in contributing to economic growth in Scotland, stating that HSBC is “very much focused on localised lending and on thereby enabling and supporting growth in the gross domestic product of the rest of Scotland.”175 Whilst he stressed that HSBC was “open to all types of Scottish businesses”, HSBC could offer unique services to “support export-oriented business” as Scotland moved into recovery. This included the provision of support to the oil and gas sector and the renewables sector. He confirmed that the fastest-growing part of HSBC’s business banking had been in the oil and gas services sector.

254. In written evidence submitted to the Committee by Barclays, it indicated that it had “a relationship with over 50 per cent of large private and Scottish plc companies” and that it was ”committed to growth within Scotland and is currently expanding its capability to ensure it continues to provide a service to its existing and potential clients in Scotland.”176 Barclays emphasised that its commercial banking division had “an embedded position with Scotland’s oil and gas sector in particular, where it employs an Aberdeen based team which provides banking services to companies operating exclusively within the exploration & production and service sectors of this industry.”177 It had also established a renewable energy team in Edinburgh in 2009 and described Barclays as a “prominent lender in Scotland’s Housing Association sector.”178

255. Another crucial issue in the future is the development of a banking sector that supports the needs of the economy and responds to the needs of customers. As noted above, businesses of all sizes across Scotland have experienced problems in accessing credit, which has compounded the difficulties that they have encountered in weathering the recession. In addition, foreign lenders withdrew at the beginning of the crisis. This has raised considerable concern among the Committee members as to how Scotland’s key sectors will be able to develop economically in the future.

256. One positive development in this bleak context has been the growth of business banking by the Clydesdale Bank, Barclays and HSBC. The Committee particularly welcomed the commitment made by HSBC to investing in the oil and gas sector in Aberdeen and the North-East of Scotland and the recognition by HSBC’s Scottish Chief Executive that the renewables opportunity was an important one and one that HSBC perceived as a potential area for investment.

257. The Committee’s inquiry has also provided evidence of a growing disconnect between decision-making on lending in banks and the local community. The Committee is concerned by the apparent reduction in the availability of advice to businesses and the evidence that suggests that there is less local decision-making on loans. The Committee is of the view that if there is a trend towards reducing local expertise and a move away from decision-making at the local level, then this might result in loan applications being considered by banking employees with less understanding of the local economy or the business concerned to the ultimate detriment of the economy. The Committee calls on banks that engage in lending to businesses in Scotland to take steps to draw on local knowledge and take decisions locally. The Committee believes that business relationship managers at the local level need to be empowered to take decisions on lending that are linked to local economies.

258. The Committee’s inquiries into tourism and energy earlier in this parliamentary session both drew attention to the vital need for investment in these sectors in order to achieve growth.179 The Committee’s tourism inquiry report called for consideration to be given to a tourism investment bank.180 Additionally, in particular, the opportunities for developing the renewables sector in Scotland may be hindered by the reduction in available finance or changes in lending patterns among the banks. It is also clear that economic regeneration has been affected by the decline in land values and that the construction industry has suffered as a result of reduced property values and increased difficulties that individuals are having in gaining mortgages.

259. The Committee notes that the Scottish Government announced in April 2009 that it had allocated £150 million for the establishment of a Scottish Investment Bank. We note that the Scottish Government did not refer to the proposed Scottish Investment Bank in evidence and the Committee will therefore seek clarification from the Scottish Government on the role of this institution. We also encourage the Scottish Government to continue to monitor SME access to finance by updating its survey on a regular basis while concerns still exist over access to finance.

The financial crisis, the recession and job losses

260. As the UK emerges from recession at the beginning of 2010, the Scottish financial sector presents a very mixed picture. The Committee’s inquiry has produced widespread evidence testifying to the strength and vigour of many areas of the financial sector, while Lloyds Banking Group and Royal Bank of Scotland are still in the process of restructuring and trying to restore their balance sheets. The Committee believes that despite the financial crisis, there are important strengths and signs of growth in the sector.

261. The impact of the financial crisis has not been restricted to the financial services sector alone. Until sectoral figures are available for the whole of 2009 it will not be possible to assess which sectors of the Scottish economy have been worse hit by the financial crisis and the ensuing economic recession. It may be that the strengths of other parts of the financial sector contributed to an overall resilience within this sector. While unemployment levels have risen and continue to rise in Scotland, the large-scale redundancies expected at the time of the Lloyds TSB and HBOS merger announcement have been postponed, and potentially averted, by the European Commission’s State Aid decision. This places an obligation on LBG not to run-down its Lloyds TSB branch network before the sale. While the redundancies at RBS and LBG must be regretted, the immediate scale of these has not been as high as was initially feared.

262. Jim Watson, the Chairman of the Financial Sector Jobs Task Force, gave an overview of the redundancies to date—

“In general, until about the end of October, it felt as though we were weathering the storm fairly well. We were faring better than expected, although that is no consolation for the people who are leaving employment, of course. At the end of November, the announcements from the Royal Bank of Scotland and Lloyds Banking Group were a sharp reminder that we are not out of the woods. During the next six months, the task force will need to continue to work closely with financial services businesses.”181

263. The Task Force commented on the difficulty of identifying the exact number of people who had been made redundant in the financial sector as a result of the financial crisis. Jim Watson provided the following estimates of job losses based upon the work of the Task Force—

“We all know the difficulties of trying to assess with a degree of accuracy the actual impact on employment. Certainly, if we compare the losses in gross value added over the past seven quarters with the employment loss, it appears that there has been a lag in job losses.

“We have been notified of around 2,500 job losses, primarily in the banking sector. The vast majority - more than 70 per cent - are voluntary redundancies, with quite a large proportion being earlier retirement; one in seven is a compulsory redundancy, which we believe is below the United Kingdom average, so we have fared slightly better in that respect.”182

264. The purpose of the Task Force has been to minimise job losses and retain the skills-set within the sector as far as possible. As a predominantly public sector body, the Task Force has aimed to ensure the coordination of support services from the public sector to the financial services industry. In evidence to the Committee, the Task Force indicated that there had been success in redeploying staff, with between ten and 28 percent of staff finding alternative jobs in the financial sector. Those that have been made redundant are from a range of different areas, but generally in the lower-value.

265. Unite the Union also recognised that the final figure for job losses in Scotland would not be known until the restructuring at LBG and RBS had been completed and the divestments made. Rob MacGregor suggested that there would be a significant impact in Scotland with many banking employees affected by the changes.

266. In evidence to the Committee, Stephen Hester indicated that “to date, however, RBS in Scotland has lost just over 800 jobs, of which only one seventh were compulsory job losses.”183 He also confirmed that “the largest announcements that we have to make on jobs have already been made” and that “any further announcements are likely to be significantly smaller in scale.”184 Andrew McLaughlin emphasised that of the job losses at RBS, the compulsory redundancy rate in Scotland of one in seven compared positively to the compulsory redundancy rate of one in four in the rest of the UK. He attributed this to a high level of redeployment in Scotland which was “partly a testament to the fact that the Scottish Government, local authorities and Scottish Financial Enterprise have got together in the jobs task force, and because, when we have known that there were going to be redundancies or office closures, we have worked effectively to proactively redeploy people and put as much support as possible around people who have been at risk.”185

267. Archie Kane set out the situation in relation to job losses in Scotland at LBG. He stated that up until October 2009, LBG has announced 1,000 job losses in Scotland, primarily from the retail bank, group operations and the insurance division. He added—

“We are just short of a year into an integration that will take two to three years, so although we are quite advanced in what we are doing, we still have quite a long way to go. In November, we tried to look forward to the end of 2010 for the projects that we felt were sufficiently advanced. We announced further job losses through to the end of 2010 in group operations - insurance in particular, in Scotland - which will be another 500-plus jobs, but that will be all the way through to the end of 2010. We have tried to give as much notice as possible, but that does not mean that that will be the end of it. There will be projects in other parts of the business as we go forward.”186

268. The Committee recognises that final figures for redundancies resulting from the crisis is currently unknown and may not be clear for some time. Although redundancies may not have been on the scale anticipated at the time of the collapse of RBS and the takeover of HBOS, a significant number of people have lost their employment and many may be still be concerned about their jobs in the future. The work of the Financial Sector Jobs Task Force is to be commended for having alleviated the impact of the job losses and for having sought to retain the skills in the sector.

The reputation of Scotland’s financial sector

269. During the course of the inquiry, the Committee sought the views of witnesses on whether Scotland’s reputation as a centre for financial services had suffered as a result of the financial crisis. The Committee’s inquiry produced mixed evidence as to the impact of the failure of the two Scottish banks and the Dunfermline Building Society on the reputation of Scotland’s financial sector. While acknowledging that the two banks have undergone reputational damage, witnesses emphasised that the whole of the international banking sector had experienced damage to its reputation, which – in part – offset the severity of what had happened in Scotland.

270. A number of witnesses stressed the fact that financial institutions, particularly banks, throughout the world had suffered reputational damage. For example, Gillian Tett commented—

“Almost nobody has emerged with their reputation intact from the past few years, although perhaps the Australians and Canadians have done a bit better than most. However, as I said, nobody right now would put Scotland in the same category as Iceland. It has certainly not done Scotland's reputation a lot of good, but if there was ever a good time to have your reputation go bad, it has probably been the past couple of years, if you see what I mean.”187

271. Maggie Craig, the Acting Director General of the Association of British Insurers, said—

“It would be stupid to deny that the global reputation of financial services - particularly the reputation of the banks - has suffered severely, but the surveys and other work that we have done with our members, many of whom operate globally, provide no evidence to suggest that Scotland's reputation has been disproportionately damaged. That may be small comfort, but it is a point worth making.”

272. The Cabinet Secretary for Finance and Sustainable Growth warned against “trashing the country’s reputation in financial services, which has been built up over 300 years, because we have had two difficult years.”188 He also emphasised the global character of the financial crisis and the fact that financial institutions all over the world had failed—

“In the past two years, many financial institutions in different countries around the world got into very severe financial difficulties. More than 100 institutions in the United States got into financial difficulties, but I do not see the United States going around beating itself up about the failure of some of its financial institutions. Therefore, I do not see why we should go around beating ourselves up about that. There is a real danger of our talking ourselves into a reputational problem that we do not need to have. There are still many attractive and positive reasons why people would want to be employed in Scotland’s financial services industry… The Government would certainly support that outlook and perspective.”189

273. Other witnesses emphasised the importance of the other financial services areas that had been less implicated in the financial crisis. For example, Mark Tennant, the Industry Deputy Chair of FiSAB, stressed that the reputational damage was limited to the banks and that there are other areas of the sector which continue to thrive and have not experienced any reputational damage—

“We need to make very clear to the press and everyone else, particularly in Scotland, that although we have had a banking crisis and there are difficulties in the banks, the financial services industry in Scotland is alive and extremely well. If we consider the insurance companies, the asset managers and, in particular, the asset servicing companies - the companies that do fund accounting and much of the clerical work in the fund management and insurance industry - it is clear that Scotland is a leader in Europe, along with Dublin and Luxembourg. The financial services industry is a high-employment industry.”190

274. Mark Tennant also stated that the reputation of the Scottish financial sector had not been damaged abroad and that “for those looking in, it appears to be nothing like as bad as we think it is.”191

275. The trades unions emphasised the low levels of morale among staff in the banking sector following the financial crisis, particularly in the context of further redundancies and widespread press criticism of the banks and remuneration regimes. Unite the Union, in evidence to the Committee, stated—

“It is hard to overstate the impact that the financial crisis has had not just on employment within the sector in Scotland and elsewhere but on the morale of the remaining workforce. It has had a devastating impact. The many certainties that people had about their working life within financial services have been shaken to their very foundations.”192

276. The Committee feels that it is too early to arrive at a final assessment of the impact of the crisis on the reputation of Scotland’s financial sector. Moreover, it considers that focusing on developing a successful future for this sector is the critical issue at this juncture. The need is for a vision for a robust and thriving financial sector in the future, rather than beating ourselves up over the events of the past.

Strengths in Scotland’s financial sector

277. The Committee heard positive evidence testifying to the strength of the insurance, life, pensions, investment management, asset servicing, building societies and some banks. We heard that there is a considerable breadth of activities, there are significant clusters of firms, there is a mixture of firms - including those established and headquartered in Scotland, offices of UK firms and offices of international conglomerates - and there are many different sizes of operation. David Thorburn commented—

“[I]t is important to remember that there are three legs to the financial services sector in Scotland. Banking is one, and it has had its difficulties, but fund management and insurance have come through the downturn remarkably well, which is a credit to businesses in those areas.” 193

278. David Nish, the Group Chief Executive of Standard Life, emphasised the strengths of Scotland’s financial sector outside banking. He stated—

“In financial services in Scotland, we are exceedingly strong in insurance and investment management. Then there are areas such as pension provision, fund management support and stockbroking - the whole back-office sector. Those sectors have managed to weather the crisis relatively well. In the insurance sector, which takes us back to my particular business, it is obvious that we were affected. Our customers were affected and, more importantly, our counterparties were affected -we were companies that traded with the banking sector and we were also investors in it. However, we should not let ourselves be drawn into thinking that "the banks" means the same as Scottish financial services. Financial services go beyond that.”194

279. The Scottish Government Financial and Business Services Key Sector Report on the finance and business sector pointed out that one of the attractions of Scotland as a location for financial services was its relatively lower cost as a location—

“Scotland has always positioned itself as a low risk, lower cost location where companies can take advantage of the existing infrastructure and assistance available to achieve operational cost efficiencies and saving. Where firms are being driven to reduce costs, this gives Scotland an advantage for any company wishing to expand and grow its business here.”195

280. This view was shared by Owen Kelly, Chief Executive of Scottish Financial Enterprise. He explained the attraction of Scotland for foreign investors—

“One argument that we certainly make to potential investors is that they will get higher quality for the same money if they come to Scotland... As I said, this period of difficulty is perversely an opportunity for us, which is why we have continued to work closely with the Scottish Government and the UK Government to promote Scotland as a location for international financial services. Costs are an important part of that. We are not a low-cost location - there are cheaper places - but the balance of quality and cost is pretty good.”196

281. State Street, which established its Edinburgh office in 1998 following the purchase of the Bank of Scotland's trustee business, indicated that cost and quality of life were key factors in its decision to locate in Scotland. Steve Smit, the Head of State Street Investor Services UKMEA and Global Markets EMEA, said—

“Cost is another important factor. As Edinburgh is second only to London as a major financial centre in the UK, it has many of London's advantages while being a more cost-effective place in which to operate.”197

282. Individual companies in the investment management, life, insurance, pension and asset servicing sectors that gave evidence to the Committee also expressed confidence in these sectors and their future in Scotland.

Insurance, life and pensions

283. Archie Kane listed the individual businesses that formed the LBG insurance division. These include Scottish Widows, Clerical Medical, Halifax Life and a range of other smaller brands, and Lloyds TSB General Insurance and Halifax General Insurance. All of these are headquartered on the Mound in Edinburgh but operate throughout the UK. Edinburgh is a primary hub for LBG’s life and pension businesses, which have the largest market share in the UK. Archie Kane also articulated a commitment to growth in this sector—

“I fully intend the insurance businesses to grow. The insurance market is quite fragmented. Although we are number one, market share varies between 10 per cent and 16 or 17 per cent in the various individual product markets. There are therefore no restrictions on trying to grow those businesses, and we fully intend to grow them. If we think about it from the point of view of Scotland, having the headquarters of the biggest life company in Britain in Edinburgh is quite a new thing.”198

284. LBG has also transferred activities relating to the handling of funds from Insight Investment Management (following its sale to the Bank of New York Mellon Corporation) to Scottish Widows Investment Partnership (SWIP), which is based in Edinburgh. Archie Kane indicated that this would result in SWIP handling “£120 billion to £125 billion of funds, which will make it one of the biggest fund managers in the UK. It is based in Edinburgh and run from Edinburgh - it is a Scottish institution.”199 He also expressed the expectation that SWIP would grow further in the future.

285. Standard Life was established in Scotland in 1825. It provides pensions, life assurance, investment management and health care insurance to just over 6.5 million customers worldwide and has £140 billion of assets under management. Standard Life employs 10,000 people in the UK, North America, Europe, India and China, with 6,000 of those staff employed in Scotland.

286. Parts of the insurance sector, including Standard Life, experienced a crisis in 2003 and as a result reviewed their policies on capital reserves and risk management. Maggie Craig of ABI stated that at this time prudential regulation was reformed and an individual capital adequacy regime was introduced in the insurance sector. David Nish explained that Standard Life had changed its business model significantly in 2004 to remove unrewarded risk. As a consequence of this, David Nish stated—

“Standard Life has weathered the crisis well. I attribute that to the disciplined approach that we took to financial and risk management. That enabled us to drive a strong capital base, and it positions us well for the economic recovery that it is hoped will come through.”200

287. In his capacity as the new Group Chief Executive, David Nish, confirmed that Standard Life was a “Scottish-based company” and that “any decision to change any of that deep-rooted Scottish base would have to be based on an overwhelming case. It would have to be either driven by a strategic change in the group or based on certain competitive circumstances that do not exist today.”201 He further added that the company was proud of its Scottish roots and “what it gives us, especially the talent of our people and the skills that we are able to build” and that Standard Life’s Scottish roots still played well when the “business travels, as we have deep-rooted associations.”202

288. David Nish indicated that Standard Life Investments had experience growth over the last year—

“My investment company, Standard Life Investments, has grown, and the largest amount of new inflows of assets has been in the past 12 months. We now have third-party moneys as nearly 40 per cent of our business. That number started as zero, in effect, 10 years ago.”203

289. David Nish also expressed the expectation that Standard Life would grow over the coming years. He stated—

“It will primarily be driven by organic growth, but we will use inorganic to accelerate organic growth. For example, we bought a highly successful small Scottish company, Vebillionet, at the tail end of 2008… It is a small company - it cost us about £25 million - but it has global brand names in its client list and it is a very exciting opportunity. That is a skills set and proposition that we did not have, but we acquired it. Our strategy is organic and is driven by the customers. If we need to fill in an asset class, skill, talent or operation, we would consider acquiring it, but it would be nothing that I would paint as large scale.”204

290. In evidence to the Committee, Maggie Craig - the Acting Director General of ABI - described the position of the insurance, life and pensions sector more generally in Scotland. She also stressed the fundamental differences between the business models in insurance and banking—

“Banks are essentially in the business of borrowing short to lend long… the technical term for that is maturity transformation. Insurers are in a different business; they are about managing assets and liabilities, so the insurance industry does not start with such a duration mismatch, as we might call it. That is a fundamental difference and one reason why insurers are much less likely to suffer from the sort of liquidity problems that brought down the likes of Northern Rock. Insurers do not do the casino banking that the banks do; they do not undertake trading operations in the same way and their business is much less liquid. For example, people cannot take money out of their pensions before age 50 or 55, so we will not get a run on an insurer that has a lot of pensions business on its books in the way that we would get a run on a bank. Those are technical differences that perhaps do not sound exciting but, if we are examining the business model, matter a great deal.”205

291. Maggie Craig explained that of ABI’s members, a number had headquarters in Scotland; Standard Life and Scottish Widows are headquartered in Scotland, as is AEGON's UK business. She also stated that a number of ABI’s members were significant employers. This included Aviva, which has expanded in Scotland, and Royal Life’s Scottish-based business: Scottish Life. Maggie Craig identified a number of hubs for insurance in Scotland. Edinburgh has a long history as a hub for life insurance, as well as being one of the biggest centres of pensions technical expertise in the UK. Glasgow’s role in life insurance has developed and the Perth area is also being increasingly seen as a hub for general insurance with the growth of Aviva’s business there.

292. Maggie Craig also stressed the size of the UK insurance and its Scottish presence. She stated that the insurance industry in the UK is the largest in Europe and third largest in the world and that between 20,000 and 25,000 people are employed in the insurance and financial services industry in Scotland. She estimated that another 3,000 are employed in investment management, with about £580 billion under management.

Investment management

293. The investment management sector is another key area of strength. Willie Watt, the chief executive of Martin Currie, gave evidence to the Committee on the size of the sector in Scotland and the breadth of its activities—

“Investment management in Scotland manages about £600 billion of assets. Broadly speaking, that makes it the 11th-largest financial services centre in the world. Within equity investment management, Scotland is probably in the top 10, because it has a greater preponderance of equity investment management than exists in other countries. For example, in Europe, investment management is dominated by bonds, rather than by equities. Three thousand people are directly employed in the industry in Scotland, mostly in Edinburgh, and there are a further 4,000 jobs in the investment servicing part of the industry - in the back offices, in which jobs are more broadly spread among Edinburgh, Glasgow and Dundee.”206

294. Bryan Johnston, the Divisional Director of Brewin Dolphin provided his views on the reasons for the success of investment management in Scotland—

“It is recognised that wealth can still be successfully managed from up here. People like the quality of life in Scotland; they may or may not appreciate the quality of life in London. People certainly appreciate the quality of advice that they receive from the various financial institutions up here. That, of course, embraces advice from the insurance companies, which are significant and important, and from the investment and unit trust industries, which are equally important. The Baillie Giffords and Martin Curries of this world are extremely important managers of money and extremely important employers.”207

295. Stuart Paul, an investment manager, commented on the heritage provided by the investment trusts, pointing out that “Scotland was one of the leading investors in the emerging markets during and at the tail-end of the industrial revolution and such dynamics are very well regarded by international investors.”208 He also argued that—

“…our international brand and educational and business reputation are still regarded as very strong. Part of that comes down to weight of money. Some very sizeable pools of assets are still being managed here, primarily through the life companies, and that source of capital acts as a commercial imperative for companies. In my working lifetime, a lot of businesses in the industry have regenerated through spin-offs and start-ups that have subsequently been quite successful, and a number of independent firms have continued to grow.”209

296. The investment managers that gave evidence to the Committee testified to the diversity of their clients and the provision of their services throughout the globe. Stuart Paul and Angus Tulloch indicated that over three quarters of their funds for investing came from overseas. The figure for Martin Currie was similar. Willie Watt explained how this provided revenue in Scotland and high-end jobs—

“The industry has a global reputation: some 75 per cent of Martin Currie's clients are outwith the United Kingdom and many other companies also have substantial client bases outwith the UK. When I travel to the USA, Australia or Hong Kong, I frequently come across my competitors from Edinburgh - the Edinburgh companies are well known around the world. Those companies bring a lot of revenue into Scotland and provide a tax-paying base. The jobs that they provide are high quality and well paid, and the individuals who work in the industry pay a lot of personal tax. Furthermore, because of the international element of the business, they bring in a lot of foreign exchange.”210

297. Investment managers also provided services within Scotland, contributing “components to those policies and pensions through local authority pension schemes, the insurance element of the industry and the unit-trust side of it.”211 The evidence from investment managers pointed to the success of the sector in weathering the financial crisis. Angus Tulloch categorically stated that—

“The impact has been nil. Fortunately, we have not been associated with what has gone on in the banking sector. We are a very different industry. There has been no impact at all.”212

298. Willie Watt suggested that the positive reputation of the investment management sector in Scotland had helped to offset the more negative impact of the financial crisis in the banking sector—

“During the financial crisis, there has been a lot of talk about reputation, and the reputation that investment management in Scotland has around the world is good. That has continued throughout the crisis, and is one of the things that offers something of a counterbalance to the damage that has been done to Scotland's reputation by the financial crisis.”213

299. The investment management sector in Scotland has given an impetus to the development of the asset servicing sector. Steve Smit of State Street stated that—

“Scotland's asset servicing sector … has grown rapidly from a standing start in the mid-1990s to become a key driver of employment growth in Scotland's financial services industry. Many other global asset servicing companies have operations here including Bank of New York Mellon, Citibank, BNP Paribas, JP Morgan and Morgan Stanley and a total of 3,800 staff are employed in the sector in Scotland. In fact, the country now has one of the largest concentrations of asset servicing companies in Europe, which is good news for us and the other companies. It means, for example, that we can attract leading talent, because people know that they can build a career here.”214

Asset management

300. Steve Smit attributed the growth of the asset servicing sector to the development of a cluster-effect. He said that “once an institution establishes a presence somewhere, the others tend to follow because there is a readily available pool of experienced labour.” The fact that Edinburgh is a major centre for investment management also supported this growth as companies could “locate themselves in close proximity to a major segment of their client base.”215

301. This evidence that the Committee heard on the vibrancy of the financial sector outside banking indicates that Scotland is not only a place to conduct business, but also a location to do business from. The inquiry shows that there are a number of Scottish companies that have a global reach, whether it is in insurance, life products, investment management or asset servicing. Scotland may be a country on the geographical periphery of Europe, but it has a global position in finance. The Committee is encouraged by the positive evidence that has emerged from the inquiry that testifies to the strength and diversity of the financial sector in Scotland and believes that it is critical for the Scottish Government to support sustainable growth in this sector.

The banking sector – survivors and new entrants

302. The Committee’s inquiry has revealed evidence of positive developments in the banking sector, both in terms of existing banks that have withstood the financial crisis and of new banks entering the Scottish market.

303. The Clydesdale Bank, as the third largest bank in Scotland, has seemingly emerged strongly from the financial crisis. David Thorburn attributed Clydesdale’s position to three key factors. Firstly, he emphasised that “Clydesdale Bank is a very traditional, conservative banking organisation that has never really strayed away from its roots.”216 Thus, it had not engaged in more aggressive forms of lending. Secondly, it had been conservative about “the amount of growth that the bank allows on its balance sheet in proportion to its capital base”217 not straying beyond “20 times its capital base at any point in the past five to 10 years.”218 Thirdly, it had funded lending primarily through its customer deposits and had less exposure to wholesale funding. As a result of these three factors, the Clydesdale Bank proved to more resilient than many other banks during the crisis.

304. The Clydesdale Bank, is part of the National Australia Bank (NAB) Group, and is committed to organic growth in Scotland. David Thorburn indicated that “in 2006 and particularly in 2007 and 2008, and in 2009 Clydesdale Bank was one of the fastest growing banks in the UK.”219 David Thorburn stated that Clydesdale Bank had been able “to stay open for business” without changing its lending policies throughout the crisis, emerging from the crisis in a strong position as—

“…the only medium-sized bank left in the UK. We are the only medium-sized, full-service commercial bank in the UK with a UK footprint. We offer choice in the market. There are the big banks, Clydesdale and a few niche players - although not many of those are left. We have an opportunity to gain market share, we are taking advantage of that and we intend to continue to do so.”220

305. The Clydesdale Bank also demonstrated that it had relatively little adjustments to make to its corporate governance or risk management policies to satisfy the changes required by the FSA of banks. David Thorburn stated—

“In simple terms, we agree with the changes and intend to comply with them; in most cases, we already do so. As I mentioned, we already have a remuneration policy, which requires only minor tweaks, and risk committees. The proposals will not have a huge effect on us. We have noticeably more interaction with regulators than we used to, but we have no complaints about that, as they are doing an important job. It seems to us that a lot of important lessons have been learned as a result of the crisis. The governance structure is being strengthened and we will fall into line behind that.” 221

306. David Thorburn underlined that the Clydesdale Bank had been committed to organic growth for a number of years, but that this would not rule out acquisitions, including those that might emerge from the LBG and RBS divestments—

“In general, our publicly stated position, certainly since 2004, has been to pursue an organic growth strategy. Doing that successfully does not require us to make any acquisitions. The position is still the same. Equally, we have said that we will look at anything that becomes available that might allow us to accelerate that organic growth strategy. To an extent, the events that are playing out in the market at the moment fall into that category. It is still early days. It is clear that there would be no competition barrier at a UK level, because our market share in the UK is small in any product line.”222

307. John Rendall, the HSBC CEO for Scotland, emphasised to the Committee that the scale of HSBC’s operations in Scotland was often underestimated—

“I have around 3,000 HSBC colleagues in Scotland. Aside from those based in our branches in Edinburgh, Glasgow, Perth, Inverness and Aberdeen, the corporate banking teams and the commercial banking teams, about 2,000 colleagues work in two of our major United Kingdom contact centres, which are based in Hamilton and Edinburgh Park.”223

308. John Rendall stressed that HSBC was in the process of growing its presence in Scotland—

“We are growing all parts of our business in Scotland and we are investing for continued growth in our business in Scotland. In the first half of this year alone, we increased our lending to businesses in Scotland by 32 per cent. We are just completing a £5 million investment in upgrading our Edinburgh Park contact centre and we are in the process of increasing the size of the team at that centre by around 10 per cent—about an additional 70 people.”224

309. There have also been new entrants to the banking sector in Scotland. Tesco Personal Finance was initially a joint venture between Tesco and Royal Bank of Scotland. In July 2008, Tesco announced that it would purchase the Royal Bank of Scotland's 50 per cent stake in the company for £950 million and in October 2009, it started operating as “Tesco Bank”, with its headquarters established in Edinburgh.

310. In August 2009, Tesco received a £5 million Regional Selective Assistance (RSA) grant from the Scottish Government to locate a new customer service centre. The Scottish Government stated that it had awarded the RSA grant to support the investment of £10.2 million in Glasgow. It was announced that 800 staff would be recruited for the customer service centre in Glasgow, in addition to 500 that would transfer from RBS.

311. In response to questioning by the Committee, Benny Higgins – the Chief Executive Officer of Tesco Bank – explained the reason for headquartering the Bank in Edinburgh—

“The answer to that is quite simple. We could have based our big service centre anywhere in the country and, when we looked around at where to base it, many parts of the country expressed a great desire for us to do so there. A wide range of factors was taken into account, of which economics was only one. The most important factors were the pool of talent and the availability of the right kind of skills in the area. Economics was a consideration, but I, for one, am delighted that Scottish Enterprise supported us in making a decision that was based not just on economics but on a wide range of factors.”225

312. Benny Higgins suggested that Tesco Bank would drew on the Tesco store network to provide infrastructure in the expansion of the Bank, explaining that they had identified a market among consumers to be able to bank and shop in the same location. He also emphasised the fact that the Tesco Bank model was a very simple one, being funded by retail deposits—

“Tesco Bank has its own banking licence and its own balance sheet. We are regulated by the FSA as a stand-alone entity. We have a cautious balance sheet, because we are entirely funded by retail deposits, as of now. We are setting out to be a stable, cautious bank that stands on its own two feet and is regulated as such.”226

313. Another new entrant to the Scottish market was Virgin Money. In written evidence to the Committee, Virgin Money Indicated that its “aspiration is to develop a sustainable, savings-based institution based at its core on matching assets and liabilities. We feel confident that extending this approach to the broader UK banking sector could generate considerable economic benefits for consumers and the wider economy.”227

314. Virgin Money explained the reason why it had decided to open an office in Edinburgh in 2009, in addition to its London base—

“Several key factors underlie our decision to establish a presence in Edinburgh. Of particular importance is our knowledge of a large number of very competent and experienced people who want to rebuild banking in the city – with trusted brand. We believe our central location in Edinburgh underpins our credibility with guests, partners and customers who may visit us, and the strong local skills base and transport system mean we can attract the right people to our city centre premises.

“Furthermore, our Edinburgh office is an important addition to our existing London base in respect of bringing together the right balance of experts to take Virgin Money forward. We are able to access considerable operations expertise in Edinburgh, while the technical expertise we require, for example in the treasury, fund management and legal spheres, is likely to found either in Edinburgh or in London. Having centres in both cities allows us to draw on the full range of expertise that we require across our business.”228

315. As well as being encouraged by the organic growth that the Clydesdale Bank and HSBC have achieved during the crisis, the Committee also welcomes the new entrants to the banking sector in Scotland, notably Tesco Bank and Virgin Money. The Committee welcomes the growth of banks that have exhibited more robust corporate governance, such as Clydesdale Bank and HSBC, and the entry of banks that have a simpler banking model and less exposure to wholesale markets.

Building Societies

316. Following the failure of the Dunfermline Building Society, it was acquired by Nationwide as described in an earlier section of this report. In evidence to the Committee, representatives of Nationwide indicated their intention to continue to trade using the Dunfermline brand. Tony Prestedge, the Group Development Director of Nationwide, confirmed that Dunfermline continued “to trade highly successfully, so at the moment we have no plans to integrate the brands.”229 As a group, Nationwide has approximately 1,000 employees in Scotland, with 42 Nationwide branches and 34 Dunfermline branches. Dunfermline has over 300,000 customers in Scotland. Nationwide made a three-year commitment at the time of the acquisition to maintain employment for branch employees, although there had been in the region of 20 compulsory redundancies at the Dunfermline head office.

Mutuals and cooperatives

317. In written evidence received from Cooperation and Mutuality Scotland (CMS) the contribution that co-operative and mutual solutions could make to Scotland’s economy was emphasised. CMS expressed the view that the financial crisis had demonstrated that “the widespread demutualisation of building societies and mutual insurers was a mistaken policy and that to some extent the current financial crisis is a direct result of this failed policy.”230 It argued that—

“Co-operatives and mutual financial organisations differ from their plc competitors in one crucial respect; they exist to provide a service rather than to generate profits for shareholders. This means that profits are shared amongst the members (consumers) rather than external shareholders. The Building Societies’ Association has estimated, this provides mutual organisations with a cost saving of approximately 35 per cent, which is distributed straight back to the members – through the provision of low cost borrowing, high returns on savings and dividends.”231

318. CMS also suggested that “by promoting a different model for the financial sector in Scotland there is scope for Scotland to become a leader through promoting mutual solutions.”232 The Committee recognises that cooperatives and mutuals operated safer models and that greater diversity within the financial sector – including more cooperatives and mutuals - could have reduced the impact of the financial crisis. The Committee notes the view expressed by CMS that—

“Many of the problems in the financial market were caused by financial institutions putting short-term gain first. CMS believes that it is time to think differently and we believe the Scottish Parliament, the Scottish Government and indeed the UK Government should give serious consideration to what more it can to promote co-operative and mutual financial solutions.”233

Competition in the banking sector in Scotland

319. At the time of publishing this report, the full and final text of the European Commission’s State Aid decisions on the restructuring plans that would be required for LBG and RBS had not been published. However, in early November 2009, both of these banks had released information which provided details of the divestments that would be required.

320. In evidence to the Committee, Irmfried Schwimann, Director for Markets and Cases III – Financial Services in the Directorate General for Competition of the European Commission, explained the approach taken by the European Commission to making its State Aid decisions on the banks. She set out three key principles that were applied in determining the approach to restructuring the firms concerned. The first principle was “to make the banks viable again in the long term without state support.”234 This requires banks to review and revise the systemic risks in their business models and divest any parts of the business or bank that are not viable. The second principle is “that banks that have received state aid, and their owners, must bear a fair proportion of restructuring costs.”235 The aim of this is to address the issue of moral hazard and ensure that there is burden sharing by means of the price that the company has to pay for state support. The third principle is to require that—

“…measures be taken in the restructuring to limit distortions of competition resulting from the aid that has been received. If a bank is able to remain strong or to grow in a business segment using a certain business model because of aid that has been received, that is clearly a distortion of competition vis-à-vis all the banks that have received no aid. We often look for divestments in those areas where a bank has been able to preserve a strong market position because of state aid. We also request a ban on acquisitions, so that a company cannot use state aid to acquire new companies or stakes elsewhere, and other behavioural restrictions to address distortion of competition. For example, a bank may not be a price leader in a particular market segment.”236

321. Irmfried Schwimann gave the Committee figures on how competition in the banking sector Scotland would be affected by the divestments—

“Lloyds has announced that it will divest Lloyds TSB Scotland, which represents about 16 per cent of the Scottish personal current account market. RBS has announced that it will sell its NatWest branches in Scotland, which represent about 6 per cent of the Scottish small and medium-sized enterprise market.”237

322. Irmfried Schwimann also commented on the impact that the European Commission hoped the divestments would have on the competitiveness of the banking sector in Scotland—

“We think that the divestments I have described will have a strong pro-competitive impact on the Scottish market because, if you look at those companies' market share—Lloyds Banking Group has 47 per cent of the Scottish personal current account market—a new entrant into the market should be positive for competition and for consumers as it will increase choice.”238

323. The State Aid decisions for RBS and LBG were both negotiated between the European Commission and HM Treasury, which included the two banks in the discussions. In evidence to the Committee, Irmfried Schwimann confirmed that while the Member State was the party that the European Commission negotiated with, the European Commission was open to representations from other parties—

“Our normal interlocutor is the Government of the member state concerned, which can choose who it draws into the talks with us. However, evidently, we would consider with interest any representation that a third party makes or any information that it provides. I am not saying that we would not look at it.239

324. The FSA confirmed to the Committee that it would have a role following the purchase of the divestments and that it would “take an interest by approving the final owners of those businesses”240 It confirmed that “as long as the institutions and anyone buying their businesses meet our requirements, we will encourage and support their plans.”241 The FSA also confirmed that “an existing institution within the EU can branch in if it is regulated in the EU” but that “the normal route for an outside institution is for it to set up a UK subsidiary for its operations. It therefore depends on where the buyers emanate from.”242

325. The Committee considers that the divestments required by the European Commission present a ‘once-in-a-generation’ opportunity to open up the banking sector in Scotland. The Committee welcomes the evidence submitted by HM Treasury, which indicates that the “Chancellor has made it clear that the RBS and Lloyds divestments resulting from the restructuring should be managed in such a way as to increase competition” and that “in line with this objective purchasers of the divested businesses will be limited to smaller providers and new entrants.”243

326. While it is not the Committee’s role to express a view on exactly who it would like to see purchase the Lloyds TSB or the NatWest branches, we believe that it is essential that the successful purchasers have a commitment to expanding banking services in Scotland with a view to promoting further competition and providing banking services that individuals, communities and businesses need. We note the importance of some form of ‘branch structure’ with decision-making at the local level to serve customers and small businesses, particularly in rural areas. These types of criteria should be the measure of success of the divestment process and should be the priorities of the Scottish Government’s interventions in the debates on the decisions to be taken.

327. The Committee is firmly of the view that a greater number of lenders will promote competition in Scotland and help to reduce the degree of exposure that Scotland has to systemic risk.

328. In addition to new entrants in the banking sector, the Committee would also like to see the introduction of measures to support the development of building societies, financial cooperatives, mutuals, credit unions and savings trusts. Scotland had a fine tradition in locally-based institutions of this type in the earlier part of the twentieth century and the Committee believes that these types of financial institutions can contribute to community development and offer consumers – particularly the less well-off – with valuable financial support and services. The evidence presented to the Committee by the Post Bank campaign indicated that small businesses groups and others such as the elderly could benefit from locally based banking facilities.

329. The Committee believes that a fundamental role of banks and building societies has to be to provide services to consumers, whether they are individuals, businesses, public bodies or third sector organisations. Sustainable economic development in Scotland requires the support of banks in the form of lending to the real economy. Consumers need to access banking services on fair and equitable terms, without being put at risk by the banks’ lending practices. The Committee therefore calls on the banks and building societies based in Scotland to consider their social utility and their broader role in Scottish society with a view to supporting sustainable economic growth.

Royal Bank of Scotland and Lloyds Banking Group

330. At the conclusion of the Committee’s inquiry it was clear to it that the primary concern in relation to the financial services sector was Scotland’s two main banks. The evidence in relation to the other parts of the sector has indicated some temporary concerns linked to the crisis, but the overall picture was positive.

331. UK Financial Investments Ltd (UKFI) was established to manage the UK Government’s investments in financial institutions at “arm’s length and on a commercial basis” with the objectives of protecting and creating value for taxpayers as shareholders, paying due regard to the maintenance of financial stablity, and act in a way that promotes competition.244 It is a company wholly-owned by the UK Government and it manages the Government’s shares in the Royal Bank of Scotland (RBS) and the Lloyds Banking Group (LBG). A framework agreement sets out the relationship between HM Treasury and UKFI in relation to the banks.245

332. When UKFI gave evidence to the Committee in November 2009, it commented on the extent to which the two banks were beginning to recover following their bailout by the UK Government. Sam Woods, the Chief Operating Officer of UKFI, stated—

“Our impression is very much that both banks are open for business. Lloyds has opened 60,000 commercial accounts during this year, and its SME lending is up 12 per cent in the year to June. RBS has loaned £29 billion to businesses during the year, and its credit application rate is at 85 per cent, which is the same as it was before the financial crisis. I think that some figures are available for Scotland as well. The big caveat is demand. As a shareholder, we have an interest in our banks being open for business and lending. As far as we can tell, they are, but there remains the question of demand.”246

333. UKFI explained its role in managing the UK Government’s investments in RBS and LBG—

“Over the past year, UKFI has worked with RBS and Lloyds as an active and engaged shareholder… The boards of both banks have been substantially overhauled. We have been involved with both banks in developing and articulating their strategies to build long-term value and in reforming their risk management practices. We have also driven through the most fundamental remuneration reforms in any of the large banks in the world. All bonuses other than those of the most junior staff are paid over three years and are subject to clawback, and no discretionary bonuses are paid in cash.” 247

334. UKFI emphasised that its role was not to replace or substitute the role of the RBS’s or LBG’s boards—

“The nature of our role as a shareholder - it is explicitly built into our mandate to manage these investments - is that we should not be involved in day-to-day management decisions. Those are decisions for boards. Cost cuts and job cuts are very much board-level issues, so we are explicitly not engaged in such discussions. Clearly, as - we hope - a responsible shareholder, we are very concerned that the banks take the appropriate consultation steps in respect of any job cuts that they have to implement. We would certainly expect the management and the boards to be held accountable for that.”248

Royal Bank of Scotland

335. In its results for 2009, RBS reported a loss attributable to shareholders of £3.6 billion. This was a reduction of 85 per cent on its loss in 2008. Although impairments almost doubled to £13.9 billion, RBS indicated that they “now appear to have peaked”. RBS has increased its Core Tier 1 Capital Ratio to 11 per cent and reduced risk in its balance sheet.249 On the contentious issue of bonus payment, RBS emphasised that it was “guided by a policy to pay the minimum necessary to retain and motivate staff who are critical to the recovery of RBS.”250 RBS announced in November 2009 that it would place £282 billion of impaired assets in the UK Government’s asset protection scheme. It is the only bank in the UK that has entered the Asset Protection Scheme. The European Commission’s State Aid decision in relation to RBS was rendered more complex by RBS’s entry into the asset protection scheme as the size of the State Aid it received was deemed to have increased.

336. The evidence presented by RBS to the Committee in the context of the inquiry indicated that there had been significant change both in its management structures and corporate governance. The contrition of the current Chief Executive justly reflected the huge state support that RBS had benefited from. When asked by the Committee whether credibility was recoverable in the future structure of banking in Scotland, Stephen Hester – the CEO of RBS – stated—

“We will never forget what happened, nor should we. It is only through learning lessons from the past that we derive improvements for the future. I am sure that, in the future, the salutary lessons that have been learned from what happened will be built on. Both RBS and the now merged Lloyds HBOS will again be strong, vibrant and successful institutions of which one can be proud, which can be good employers and which can serve their customers and society well. I believe that that can and will happen.”251

337. In considering RBS, the Committee does not seek to delve back into the events of the past. The Committee believes that the enormous scale of the capital injection that RBS received, as well as the £282 billion impaired assets that will be covered by Asset Protection Scheme, is sufficient in itself to demonstrate the enormity of the failures in management, errors in judgement and behaviour of those at the helm of RBS. The key question in relation to RBS is what now is to be done: how can RBS restore its fortunes and how can the Government recoup its investment.

338. In evidence to the Committee, Stephen Hester explained the approach that he had taken to restructuring the bank at the senior management level, where he perceived the problems to have been rooted—

“The top level of management at the bank is my executive committee, which is made up of nine people. Every member of that executive committee was new to their job in the past year. Roughly half have come from the outside and half have been promoted in various ways from the inside.

“As I have said, however else you characterise the issues at RBS, you should remember that the vast majority of its businesses are very strong and good and, throughout all this, the vast majority of its people were doing their jobs at least adequately and often better than that. RBS's failings were overwhelmingly at the top—and I mean that in a broader sense; I do not mean to personalise the issue vis-à-vis my predecessor.”252

339. John Crompton, the then Head of Market Investments at UKFI, also indicated that it had been involved in decisions to change the management team at RBS and that the management changes had been important to renewing RBS—

“We have contributed to, and the RBS board has overseen effectively, the renewal of the management team over the past year. That started in October 2008 with the appointment of Stephen Hester, who has proved to be an energetic and effective chief executive. He, in turn, has recently recruited a new finance director, whom we regard as a world-class finance director with extensive experience. Together, they constitute the executive director component of the board. There has also been quite a lot of change at sub-board level through the management structure, which has been driven by Mr Hester. We regard that, too, as auguring well for the bank's ability to achieve its goals. It is not a case of target setting and hoping; in our view, the board is directing real change in the organisation.”253

340. UKFI also confirmed that the “entire board of RBS has been reconstituted in the past year. It has been reduced and replaced.”254 However, Michael Kirkwood also noted that—

“The question is not whether the aggregate qualifications of the outgoing board and the incoming one differ materially. RBS had extremely distinguished and prominent people on a board that failed to provide adequate governance for the company. The question is not who is on the board but what they do when they are on it and the tone that the chairman sets in challenging, probing and questioning and carrying out the fiduciary responsibilities for the shareholders and depositors in the bank. I suspect that the current board is extremely motivated to do things differently from the outgoing board.”255

341. RBS has established a set of goals for 2013, “which relate to the profitability of the bank, its ability to earn a return on equity in excess of 15 per cent, the capital strength of the bank and various other measures that should translate into a significant creation of value for the taxpayer as shareholder as well as a reinvigoration of a major financial institution and the return of that financial institution to a leading position in the national and global markets in which it competes.”256 These goals are designed to take RBS into a position from which it can return to being an independent financial institution.

342. The Committee recognises that the European Commission’s State Aid decision will substantially reduced the scale and range of RBS’s activities. In written evidence to the Committee, HM Treasury estimated that the required divestments would reduce RBS’s balance sheet by more than 41 per cent. The divestments will include the 311 RBS branches in England and Wales, seven NatWest branches in Scotland, 40 business and commercial banking centres, four corporate banking centres, two direct business banking centres, three personal relationship manager centres and three operational centres.257 RBS has also been required to make a behavioural commitment that it would rank no higher than number five in the combined all debt league tables globally for three years.

343. The State Aid decision reflected the amount of aid that was received by RBS, which was significantly larger than LBG, ING or KBC: the other big State Aid recipients in Europe. On the day that the European Commission approved the State Aid decision on RBS, the then Competition Commissioner, Neelie Kroes, said—

"This case has been one of the most complex the Commission has had to deal with during the financial crisis. I am very pleased with the result. The Royal Bank of Scotland will take a number of significant steps to return to long term viability. RBS will itself pay a sufficient share of the restructuring costs and distortions of competition will be limited by substantial divestments. I wish a better and more sustainable future to this bank. But be aware that in case RBS does not deliver on its balance sheet reduction targets by 2013, the Commission will be able to intervene again and more divestments will be required."258

344. Some of the divestments that were required of RBS were not perceived as being consistent with the objective of improving competition in the banking sector. Jeremy Peat commented—

“It is unfortunate that the insurance arms of RBS, for example, have been fingered for disposal. I do not believe that the competitive state of the insurance market is of the same level of concern as the competitive market for retail banking and small business banking. I am not quite sure why RBS is being required to sell those arms in the same breath as it is being asked to revive Williams & Glyn and set up different businesses for small business and personal banking.”259

345. The Committee notes Stephen Hester’s view that the RBS will be a universal bank with 60-65 per cent of its business in the UK and that roughly two-thirds of its business will involve basic retail and commercial banking. Stephen Hester also indicated that his three priorities were: “an enduring customer priority—we will always have customer priority; a priority to make the bank safe again, which is today's priority to get the balance sheet, the capital and the risk management right; and, later in the piece, the priority to get the taxpayer's money back.”260

346. Stephen Hester emphasised the importance of RBS share prices increasing in value so that the taxpayer’s investment in RBS could be recouped through the UK Government selling its shares. He also implied that some of the divestments required by the European Commission would make this more difficult—

“Anything that reduces our profits will make that harder to achieve and, in that sense, selling the more profitable of our businesses will make the job harder. However, because we have four years in which to do that, we will have the opportunity to get at least a fair price for those businesses and turn what is clearly a disadvantage, in terms of our future profitability, into a neutral. I hope that we can do that.”261

347. The Committee welcomes Stephen Hester’s confirmation that Scotland was very important to RBS and that RBS would continue to be headquartered here—

“Clearly, as Scotland is our headquarters, where our board meets most often and where we are incorporated, to the extent that companies have cultural hearts—we can have a philosophical debate about that—we feel grounded in this community. We feel a sense of identity in this community that would not be replicated to the same extent in other places around the world where we are present. All of that is important. Secondly, Scotland is a major area of employment for us where people with expertise that the bank needs are located. That is important for us. Thirdly, we have a valuable client base across Scotland, which is also important for us. Importance lies across each of those dimensions.”262

348. The Committee noted the comments made by Jeremy Peat in relation to the headquartering of banks in Scotland. He observed that there had been a shift in the centre of gravity at RBS away from Edinburgh and expressed a particular concern about the effect that this might have on the associated services that the headquarters and corporate offices require and on high-end employment in the financial sector—

“It does not matter where the individuals live, to some extent. What matters is that the result of having the head office here is a demand for high-quality lawyers, accountants, architects and actuaries. There is a top-grade financial and other business service sector in Scotland that starts with meeting the demands of RBS and HBOS head offices and is then available to the rest of the Scottish business sector. If, as a result of a shift in the centre of gravity, the purchasing decisions and inputs come primarily from London, there is a risk that the legal and accounting sectors and so on will have less of a scale and quality in Scotland than would otherwise have been the case. I would regret such a gap.

“Likewise, having large numbers of senior executives from those institutions in Edinburgh gives rise to demand for other services, which raises quality and adds to people's desire to come and work here. There was a time when people could readily have a high-level career in Edinburgh. If the centre of gravity shifts, that opportunity is diminished. People might go in and out of jobs, but the opportunity to develop their careers is not there. People from those institutions have no doubt gone out and started their own businesses elsewhere in financial services, or spread into other businesses, and their talent and skills have been adding benefit to the Scottish economy. Graduates from universities knew in the past that there were good careers to be had here, but now, because of the loss of the head offices, those opportunities might again be diminished.”263

349. The Committee heard evidence from UKFI Ltd that it would sell the UK Government’s shareholding in RBS once there was evidence that the UK Government’s capital investment could be recouped. It indicated that if goals in the Bank’s turnaround plan could be achieved by 2013 then this “should translate into a significant creation of value for the taxpayer as shareholder as well as a reinvigoration of a major financial institution.”264 The Committee considers that, based on share values at the beginning of 2010, that there is currently little evidence to suggest that the UK Government’s investment could be recouped in the near future and that there are many variables that could intervene to impact on the final price achieved by the UK Government on the sale of its shareholding. Particularly important from the public interest perspective will be the way in which the eventual sale of the shareholdings is managed.

350. The evidence from UKFI indicates it has taken a very narrow view of its role as set out in the Framework Document and Investment Mandate. The Committee would have welcomed evidence from UKFI that demonstrated that it engages as an institutional shareholder to promote the public interest in terms of the Government’s shareholdings in RSB and LBG. The Committee considers that in light of previous failures by shareholders and non-executive directors, it is important that UKFI should take a more pro-active role. The Committee is concerned that a focus only on achieving shareholder value may be inappropriate. The Committee believes that UKFI’s stewardship of the banks in which it holds shares should also emphasise the long-term interests of the economy as a whole, and should apply social and environmental criteria to investment and business decisions taken by those banks.

351. The Committee welcomes Stephen Hester’s commitment to the continuing headquartering of RBS at the Gogarburn site in Edinburgh. However, it notes Jeremy Peat’s observation in relation to RBS that “the centre of gravity has shifted from Edinburgh to London.”265 The Committee believes that the retention of headquartering functions will be essential in supporting the other business services associated with the presence of the bank in Scotland, particularly high-end jobs in the professions.

Lloyds Banking Group

352. The Lloyds Banking Group, on a combined business basis, made a loss of £6.3 billion in 2009. However, its total income rose by 12 per cent and costs fell by 5 per cent. The total impairments for the Group were £24 billion for 2009 “principally due to HBOS portfolios and their high level of exposure to commercial property.”266 The Chief Executive confirmed that “the Lloyds TSB conservative approach to risk management has been implemented across the Group and is making a difference.”267 The Core 1 Ratio for the Group at year end was 8.1 per cent.

353. The Lloyds TSB merger with HBOS, as noted previously, was the subject of an Office of Fair Trading investigation into whether a relevant merger situation had been created and, if so, whether the creation of that situation might be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services. In his decision on this case, the UK Secretary of State decided that the new public interest consideration relating to the stability of the UK financial system was relevant and decided not to refer the case to the Competition Commission. He was reported, however, as asking the OFT to “keep the relevant markets under review in order to protect the interests of UK consumers and the British economy."268 In response to questioning by the Committee, Clive Maxwell – Senior Director, Services, OFT – stated—

“The secretary of state referred to the need to keep the situation in the market under review; he did not specifically mention the concentration. To answer your question more directly, we are examining cross-market issues, and considering different elements such as personal current accounts. The OFT is not carrying out a new inquiry into small business banking in Scotland, if that is what you are asking.”269

354. The Cabinet Secretary for Finance and Sustainable Growth, in supplementary written evidence to the Committee, stated, “Having considered the OFT evidence session, I can see no need for additional action from the Scottish Government at this stage, beyond our continuing to make data in relation to the workings of the market in Scotland available to UK authorities.”270

355. The Lloyds TSB merger with HBOS was conducted at great speed although Archie Kane emphasised to the Committee that Lloyds TSB had done a “huge amount of due diligence”. It is now clear that Lloyds TSB took on extensive toxic assets, particularly in HBOS’s loan book.271 The UK Government’s capital intervention into Lloyds Banking Group was on a lesser scale than that of RBS, and its shareholding is 43 per cent compared to 84 per cent in RBS.

356. The European Commission also took the fact that LBG would not enter the Asset Protection Scheme into account in making its decision. Nevertheless, the divestments that LBG has to make are significant. LBG has to sell 185 Lloyds TSB Scotland branches, over 250 English and Welsh Lloyds branches, 164 Cheltenham and Gloucester branches and 19.2 per cent of the Lloyds mortgage book, Intelligent Finance and the TSB brand and an additional reduction of non-core balance sheet of £181 billion. This will lead to an overall balance sheet reduction of around 27 per cent of the relevant assets.

357. Archie Kane described the divestments that LBG has to make as a result of the European Commission decision as “painful” but suggested that it would assuage some of the concerns raised about competition at the time of Lloyds TSB’s acquisition of HBOS. He did not foresee the “process as having a significant negative impact on the development and implementation of our strategy in future”272

“As part of the resolution of the state aid negotiations with Brussels, we have had to come to an agreement whereby we have to dispose of certain parts of our business. I make it clear that that is painful. Nobody likes to dispose of parts of their business. It is hard to gain business and market share—companies compete strongly for it and defend it as best they possibly can—so it is difficult to dispose of parts of the business. However, we have come to an agreement with Brussels and, as part of that, Lloyds TSB Scotland will be divested of, as part of the portfolio of businesses that we will put together. That will take with it a significant chunk of the personal current account market in Scotland and a proportion of the SME market in Scotland. It is unclear how that will eventually land. We do not know who will buy Lloyds TSB Scotland or whether it will be floated off. We have four years to work our way through that. However, one thing is clear: it will be a separate competitive force. That, in and of itself, resolves some of the concerns that might have prevailed.”

358. In evidence to the Committee, Archie Kane explained Lloyds Banking Group’s relationship with Scotland and confirmed that the registered office for the whole group was at the offices on the Mound in Edinburgh—

“Scotland plays a significant part in Lloyds Banking Group. We are one of the largest private sector employers in the country, with more than 20,000 staff throughout Scotland; our registered office is on the Mound here in Edinburgh; and we hold our annual general meetings in Scotland. A large number of the group brands are based in, and run from, Scotland. The Bank of Scotland, Scottish Widows and Scottish Widows Investment Partnership are some examples of those brands. As the main board director with responsibility for the group in Scotland, I established the Scottish executive committee, which meets monthly in our office on the Mound and brings together senior executives from throughout the group in Scotland at managing director level to consider matters from the group perspective in Scotland.”273

359. Archie Kane also expressed LBG’s intention to be competitive and to reinvigorate the Bank of Scotland brand—

“We intend to be a competitive force within Scotland. That means that we will have to have products that are fit for purpose and those products will have to be priced competitively. Our primary brand in Scotland will be the Bank of Scotland. I mentioned earlier the difficulties that HBOS had in surviving on its own. You must realise that it had basically shut down in the corporate and SME market in 2008. It was simply not operating because it had run out of liquidity and funds. We are now breathing life back into the Bank of Scotland. It is up and running and is open for business. It is competing in the SME market and across the full range of its product set.”274

360. The Committee welcomes the fact that in Scotland the Lloyds Banking Group will trade primarily under the Bank of Scotland brand and that its insurance division will be headquartered on the Mound. The Committee also recognises that in terms of branch structure, LBG is required to divest proportionately more in Scotland. This will allow a new entrant to the banking sector in Scotland, but this will effectively equate only to a return to the status quo when Lloyds TSB and HBOS were separate entities.

361. The Committee is disappointed that the Office of Fair Trading has failed to keep a “watching brief”, as requested by Lord Mandelson, on the competition situation following the acquisition of HBOS by Lloyds TSB. Before the divestments required of RBS and LBG in Scotland have been made, the Committee calls on the Office of Fair Trading to conduct a formal investigation into competition in banking in Scotland in personal current accounts, home loans and business banking. The Committee has written to the Office of Fair Trading to request that it conduct such an investigation. We are disappointed that to date, the OFT has not seen fit to conduct such an inquiry. The Committee also recommends that the Scottish Government formally asks the Office of Fair Trading to conduct such an inquiry.275

362. Prior to the publication of the annual report and accounts for RBS and LBG, the chief executives of both banks – Stephen Hester and Eric Daniels – had confirmed that they would waive their bonuses for the year. UKFI, which manages the UK Government’s stakes in RBS and LBG, had approved the RBS 2009 bonus proposal.

363. The Committee is of the view that important elements of RBS’s and LBG’s businesses have been retained in Scotland. This is crucial in helping to maintain the critical mass of the financial sector in Scotland and support the other business services associated with it. The Committee considers it vital that the senior management of these banks draw lessons from the failings of the past and ensure that there is not a return to “business as usual” as the institutional memory of past difficulties fails.

364. Of great concern to the Committee are the representations that Committee members have received from small and medium enterprises on the difficulties that they have had in securing finance from their banks. Pre-existing business customers have found that the terms for loans or overdrafts have been changed and that the cost of refinancing has increased. Many have also found it more difficult to secure financing than in the past. Whilst the Committee recognises that there is a need among some of the banks in Scotland to improve their risk assessment procedures, it considers that the problems encountered by businesses have compounded the effects of the recession. It notes the surveys conducted by business associations that suggest that there has been an increase in loan rejections and the Scottish Government’s reports on SME access to finance which similarly identify problems in securing loans. There is also concerning evidence that small businesses are resorting to other sources of financing, such as credit cards, to secure a cash supply. Given the commitments made by the banks to provide lending, the Committee believes that business-relationship managers in banks need to be taking a more engaged role with SMEs and it calls on the Scottish banks to reassess their lending policies and their relationships with their business customers.

365. Given the number of unknowns which may intervene in the coming years as these banks are restored to private ownership, the Committee considers that it is important that the Scottish Government has a clearly developed and updated vision for the financial sector in Scotland, and the role that LBG and RBS can play in it. We consider that this vision needs to reflect the financial crisis and question whether one is in place at the moment given the evidence we heard from the Financial Services Advisory Board (FiSAB).

how can scotland help itself

366. The Committee recognises that under Schedule 5 of the Scotland Act 1998, economic and monetary policy – including the currency, financial services and financial markets – is a reserved matter. Thus, Scottish Government activities in the financial sector include the coordination of industry bodies, the promotion of the financial sector internationally, the attraction of inward investment into the financial sector in Scotland and the provision of Regional Selective Assistance grants to help attract new companies to Scotland and help existing companies remain in Scotland. At a more general level, the Scottish Government can promote educational standards and qualifications that are of value to the sector, ensure that Scotland is an attractive place to do business and assume an advocacy role to promote the sector.

367. The following paragraphs analyse the evidence collected by the Committee during its inquiry and identify the actions that the Committee thinks the Scottish Government should take to promote the financial sector in Scotland.

A strategy and vision for the financial sector in Scotland

Strategy

368. In 2005, the then Scottish Executive published a strategy for the financial services industry in Scotland. The aim was to develop a strategic view of the industry's long term potential and development needs, as well as setting out short, medium and long term actions to help realise that potential. Subsequent to the 2005 strategy document, the then Scottish Executive and now the Scottish Government has published a series of ‘annual reports’ (in 2006, 2007, 2008 and 2009) which, according to the Scottish Government, provide a summary of achievements over the year in question in terms of implementing the strategy and outline some plans for the year ahead. Finally, in addition to the 2005 strategy document, the Scottish Government published an Implementation Plan.

369. The status of all of these various types of document and whether and when the original strategy published in 2005 has been updated, was the subject of questioning by the Committee of various witnesses.

370. Initially, Mark Tennant, the Deputy Industry Chair of FISAB, was asked if it was FiSAB's intention to publish, along with the Scottish Government, a revised financial services sector strategy document in light of the problems faced by the sector since 2005. He told the Committee that the “strategy was set out by FiSAB at the very beginning, which is still in place and is evolving"276 but that "we do not publish strategies on an annual basis because, frankly, that is an absurd thing to do" 277. Furthermore, he said that "I am not sure that we will publish a fresh strategy".278

371. Jim Watson, of Scottish Enterprise and the Jobs Task Force, stated, on the other hand that "the financial services implementation group—FiSIG—has spent some time considering on behalf of FiSAB whether we should make any changes to the strategy" and that "those deliberations will be reported back to FiSAB at the next meeting in March [2010]".279 What he then suggested is that rather than publish a new strategy document, he thought that the implementation plans were "the vehicle that has been used to make changes in emphasis".280 He said that "it is clear that, year on year, the implementation plan indicates different actions and different directions".281 In his view, the implementation plan "is being used more than the strategy as the vehicle to reflect the changes that have come about as a result of the current recession".282 This tends to suggest again that the 2005 document is "The Strategy" but that it evolves and changes via the implementation plans, at least one of which was published back in 2005/6.

372. In his evidence to the Committee, the Cabinet Secretary for Finance and Sustainable Growth said that he did not want the Committee to "believe that the strategy was fixed in 2005 and that its details have never been revisited".283 He said that "FiSAB looks at an annual programme of activity to support the development of financial services in Scotland".284 He then clarified to say that "FiSAB reviews that [the strategy] on an annual basis to ensure that all the interventions that we make are appropriate and beneficial and that they support the development of the financial services sector in Scotland"285 .

373. David Wilson, Director of Business, Enterprise and Energy at the Scottish Government, then sought to clarify and said that, "the latest formal update of the strategy was in spring 2008".286 He also said of the annual reports (see above) that these "are not formal updates of the strategy, but they are updates on work in progress" and that "they show how things are being adapted, in recognition of the huge change in context." 287

374. This would appear to suggest, therefore, that the 2005 strategy document was indeed refreshed and published in 2008. However, in subsequent material provided to the Committee, Mr Wilson wrote to apologise to the Committee that his evidence during the Banking Inquiry was inaccurate and has inadvertently caused confusion. He stated that the strategy itself remains as published in 2005, other than some minor drafting changes. He also said that there had been an assessment done to ensure that the strategy remains a relevant vehicle to support the industry.

375. Finally, it should be noted that FISAB was due to meet as this report was being finalised and it is unclear whether this will result in anything being published by way of an updated strategy.

376. In order to develop a sound basis for more engagement on the financial sector, the Committee calls on the Scottish Government to develop a far more detailed and publicly available vision for the sustainable growth of the financial sector in Scotland. This should be developed in collaboration with the Financial Services Advisory Board and include an assessment of the sector, the potential for growth and the identification of the factors that can sustain and grow the sector.

377. This vision should include a blueprint for the type of banking sector that the Scottish Government would like to see in Scotland, with a strong emphasis on increased competition and diversity. It should also include the Scottish Government’s view on the HBOS and RBS divestments and how they could best benefit competition in the financial sector in Scotland. We have given our view above on the vision and we encourage the Scottish Government to build on this and bring back a report to the Parliament and this Committee in the coming months for a full debate and endorsement.

A vision for the financial sector in Scotland

Financial Services Advisory Board

378. The Financial Services Advisory Board was established in 2005 by the previous Scottish Executive. It was set up “to be the custodian and advocate of the Strategy for the Financial Services Industry in Scotland”. In 2005, the Scottish Executive, together with the industry and the trade unions, published a Strategy for the Financial Services Industry in Scotland.288 The delivery of the Strategy is managed by the Financial Services Implementation Group (FiSIG). Mark Tennant, the Deputy Industry Chair of FiSAB, explained the background to the establishment of FiSAB—

“To put FiSAB in context, it was the creation of Jack McConnell and John Campbell, my predecessor. The role that was envisaged for it is the one in which it now operates, which is to act as the communications link between the Scottish Parliament, the First Minister and the Government, and the financial services industry, which is Scotland’s second largest. FiSAB fulfilled that role extremely well under my predecessor, and I am grateful to the current Administration for picking up Jack McConnell’s ball and running with it.”289

379. FiSAB’s members include representatives of the Scottish Government and its agencies, industry representatives, a trade union representative and an HM Treasury observer.290 Although Rob MacGregor of Unite the Union welcomed the role of FiSAB, particularly as no comparable body existed elsewhere in the UK, he suggested that it would be helpful if it could meet more often and that it needed “to include broader representation.”291

380. In 2008, FiSIG undertook a scenario-planning exercise to consider what changes were necessary to the strategy as a result of the financial crisis and the recession. Jim Watson, the Chair of the Financial Sector Jobs Task Force explained how the Strategy had been updated—

“In November 2008, FiSAB carried out a scenario-planning exercise to revisit the strategy and look at the implications of the recession. … [T]he implementation plan … is the vehicle that has been used to make changes in emphasis. It is clear that, year on year, the implementation plan indicates different actions and different directions. In my view, that is being used more than the strategy as the vehicle to reflect the changes that have come about as a result of the current recession.”292

381. When questioned about the Scottish Government’s vision for how it would like the banking sector to develop in Scotland to ensure that there is competition, the Cabinet Secretary for Finance and Sustainable Growth indicated that—

“The committee’s input and inquiry will be helpful to the formulation of such a position. The Government wants to ensure that we get out of the divestment approach more active players in the banking market in Scotland. The committee’s input to the process and, I hope, a debate in Parliament will help us to refine and develop that. Of course, the divestments that the European Union requires are to take place over four years, so you are right to say that there is an opportunity to shape the agenda as effectively as we can.”293

The Finance Sector Jobs Task Force

382. In response to the financial crisis, the Scottish Government established the Finance Sector Jobs Taskforce in 2009. Its role is to co-ordinate efforts across Scotland to ensure maximum levels of employment are retained within the financial services industry. It aims to understand the needs of the industry as it adjusts to the future structures which will emerge as a result of the current climate and support the re-employment of those made redundant in alternative jobs in the financial sector so that skills are not lost to the sector. The Taskforce is composed primarily of public sector bodies, but it also includes a representative of Unite the Union. In 2009, the Taskforce met seven times. Jim Watson, the Chairman of the Taskforce, commented on the success of the model—

“We think that it has made a lot of progress in a relatively short time. The co-operation between partners in the task force has been first class and the response from the industry has also been excellent. There has been a genuine desire to work in collaboration, because we all realise that we are trying to help people through very difficult times.”294

383. As noted earlier in this report, the available data on redundancies in the financial sector, as well as accurate statistics on the financial sector more generally, are unavailable. In fact, even the Finance Sector Jobs Taskforce was unable to provide us with detailed information. The Committee considers that having accurate and up-to-date statistics on the sector is particularly important in light of the financial crisis and that it is hard to reach a final assessment of the impact of the crisis without such statistics.

384. The Committee welcomes the commitment of the Finance Sector Jobs Task Force to alleviating the impact of redundancies in the financial sector in Scotland. It also supports the Scottish Government’s continuing assistance to the Task Force. The Committee considers that the lack of accurate statistics on the job losses that have resulted from financial crisis provide further evidence on the weakness of the statistics available for this sector. It therefore calls for better and more regularly updated baseline data on employment in the financial sector.

385. More generally, in order to develop a sound basis for more engagement on the financial sector, the Committee calls on the Scottish Government to develop a far more detailed and publicly available vision for the sustainable growth of the financial sector in Scotland. This should be developed in collaboration with the Financial Services Advisory Board and include an assessment of the sector, the potential for growth and the identification of the factors that can sustain and grow the sector.

386. As the report had documented in earlier sections, the State Aid decisions taken by the European Commission will have a significant impact on the current banking landscape. The divestment by LBG of its Lloyds TSB Scotland branches and the divestment by RBS of its NatWest branches has the potential to bring new entrants into the banking sector in Scotland. Virgin Money argued—

“Returning the shareholdings to the private sector must be undertaken in such a way that competition and diversity are promoted as much as possible. The process of the UK Government’s withdrawal from owning equity in the banks presents a potential opportunity to encourage an innovative, competitive and outward-looking financial services industry in Scotland, and it is important that the Scottish Government does what it can to encourage this.”295

387. The Committee sought the views of the Cabinet Secretary for Finance and Sustainable Growth on the divestments and the potential for greater competition in the banking sector. The Cabinet Secretary stated that, “Ministers are keen to encourage more players and to ensure that the Lloyds TSB divestment gives us the opportunity to secure another headquartered institution in Scotland; a banking licence goes with the TSB network.”296 He also stated—

“There are clearly opportunities for a different type of banking structure in Scotland in the aftermath of our difficulties. I do not think that there is any impediment to that happening...It will also be interesting to see consumers’ attitudes. I certainly detect a desire for what has been referred to colloquially as boring banking, and I do not doubt that there is an appetite for that within sections of the market. People simply want to be able to rely on financial institutions without the uncertainty that they have faced during the past 18 months. I think that there is no impediment to the realisation of such an aspiration in the period ahead.”297

388. The Cabinet Secretary for Finance and Sustainable Growth confirmed to the Committee that in July 2009, he had considered it “the correct course of action” to write to the Chancellor of the Exchequer when the Scottish Government’s Access to Finance Survey 2009 was published “highlighting concerns about the concentration of the market in the provision of finance to SMEs in Scotland.”298

389. The Scottish Government’s vision should include a blueprint for the type of banking sector that the Scottish Government would like to see in Scotland, with a strong emphasis on increased competition and diversity. It should also include the Scottish Government’s view on the HBOS and RBS divestments and how they could best benefit competition in the financial sector in Scotland. We have given our view above on the vision and we encourage the Scottish Government to build on this and bring back a report to the Parliament and this Committee in the coming months for a full debate and endorsement.

390. The Committee notes the Scottish Government’s view that the Financial Services Advisory Board can act to provide a collective “Scottish Voice” on regulatory matters.299 However, in light of the potential conflicts of interest the Committee is of the view that Scottish Financial Enterprise (SFE) is the industry body in Scotland and that it is consequently the role of SFE to lobby on behalf of its members.

391. The Committee is concerned about whether FiSAB is properly constituted and reflects the interests of the real economy and banking consumers in Scotland. The Committee therefore calls for the composition of FiSAB to be reviewed with a view to establishing a body which represents not only the industry but a broader range of interests, particularly those of businesses and consumers. The Scottish Government should then draw on the views of this body to consider how it can champion a financial sector that supports the interests of the people and the economy as whole in Scotland.

Engagement

392. The Committee sought evidence from the Scottish Government on the level of communication between it and the Tripartite Authorities. The Cabinet Secretary for Finance and Sustainable Growth confirmed that “Scottish Ministers communicate with HM Treasury Ministers on a wide range of issues, both in writing and in person.”300 He also indicated that “Scottish Government officials have regular contact with counterparts in HM Treasury, Bank of England, the FSA and the OFT on a wide range of issues as part of normal working.” He highlighted the fact that FiSAB had invited the Bank of England and the FSA to take up observer status and that both of these members of the Tripartite Authorities had expressed a willingness to attend where they could be of assistance to FiSAB in its discussions. The Cabinet Secretary also concluded that—

“The regulation of financial services is a matter reserved to the UK Parliament and as HM Treasury, the Bank of England and the FSA all have responsibility for the whole of the United Kingdom on these matters, we expect all of these institutions to take full account of Scottish specific issues in their day to day operations. The Scottish Government continues to liaise with all of these organisations on an ongoing basis.”301

393. The Committee calls on the Scottish Government to initiate a step change in communication and contact at the highest levels with the Tripartite Authorities with a view to discussing issues of relevance to the financial sector in Scotland, as well as macro-prudential and broader economic issues. The Committee considers that as the Scottish Government’s overarching purpose is to promote sustainable economic growth in Scotland it is crucial that it better engages with all of the Tripartite Authorities on these issues, particular by the Scottish Ministers. The financial crisis has had such a profound effect on the Scottish economy that it is important that there is an exchange of information between these bodies going forward. This is exemplified by the situation faced by small and medium enterprises in Scotland in accessing finance over the last two years. Given the role of the Tripartite Authorities in ensuring flows of credit and that banks continue to lend, it is important that reports such as the Scottish Government’s reports on SME Access to Finance are provided to the Tripartite Authorities.

394. During the course of its inquiry – and as noted in earlier in this report - the Committee heard concerns from witnesses about the potential impact of European legislation: notably the Solvency II Directive and the Alternative Fund Managers Directive. While the Committee recognises that the representative bodies for the financial sector and individual businesses have been actively engaged in trying to influence the development of European legislation, the Committee considers that there is a particular role that the Scottish Government can play by developing its engagement in this area with the UK Government.

395. The Committee calls on the Scottish Government to engage with the UK authorities systematically at the early stages of the development of European Union legislation and emerging financial regulation, as well as on the transposition of European Union directives by the UK Parliament. We recommend that an assessment of the challenges and opportunities from future EU legislative proposals is made and shared with the Parliament.

Headquartering

396. The evidence heard by the Committee emphasised the importance of the headquartering of financial institutions in Scotland. This helps to promote high-end jobs within the institution concerned, as well as supporting other business services, particularly in the professions. The Committee calls on the Scottish Government to consider how it can support the retention of headquartering functions in Scotland and provide the detail of its plans in the report to Parliament that we have requested.

Promoting inward investment

397. The Committee calls on the Scottish Government to consider how it can promote inward investment to support the critical mass in life, insurance, investment management and asset servicing that already exists in Scotland. The Scottish Government should continue to use all measures at its disposal including RSA grants to attract new financial sector businesses to Scotland and ensure that existing companies remain. It also calls on the Scottish Government to work with the relevant agencies to promote Scottish financial service companies abroad, particularly in the emerging markets. We will return to this area in our current inquiry on international trade and inward investment policies.

Education and skills

398. Many of the witnesses who gave evidence to the Committee emphasised the importance of education at all levels. They stressed the importance of good numeracy, literacy and functional skills in school leavers as well as high-quality university graduates. Willie Watt, the Chief Executive of Martin Currie, stated—

“The issue for the Government is just to ensure that people coming out of secondary school and university have the right kinds of skills and knowledge of the system, and that careers services in schools are equipped to guide people who wish to enter the sector. When I came out of school, working in the sector was perceived as a positive thing, and people wanted to go and work for companies such as Standard Life and Scottish Widows—it seemed an exciting thing to do. Some of that has gone because of the crisis, so we need to try to get it back.”302

399. The Committee calls on the Scottish Government to promote these skills further and consider how it can deliver a skilled work force at school leaver, further education and university level. The Committee stresses the importance of highly-skilled workers and the value of modern apprenticeships in this context. The industry should also be promoted as a potential area of employment to counteract any negative impact that the financial crisis may have had on interest in the sector. We expect this issue too to be covered in the report we have requested.

Infrastructure

400. The infrastructure in Scotland, as well as the transport links between Scotland and other countries, was identified as being important, particularly in the context of Scotland’s geographic position. It was pointed out that direct flights to and from Edinburgh could facilitate business travel and contact with clients. In this context, the Scottish Government should continue to develop Scotland’s transport infrastructure and connections with other countries, particularly by means of direct flights to and from Scottish airports. In particular, travel to London – as one of the two main global financial centres – should be facilitated by a high-speed rail link.

Promoting diversity

401. This report has noted the consolidation that took place in the banking sector over the last century. Many witnesses lamented the lack of diversity in the financial sector, suggesting that more choice and competition would make the sector more resilient. Gillian Tett observed, “In an ideal world, it would probably be better to make the banks smaller and more diverse, simply because a more diverse ecosystem tends to be healthier.”303 Evidence was also presented suggesting that alternative models could appeal to consumers. It has also heard evidence from the Post Bank coalition arguing that the “post office network is ideally suited to provide banking facilities to communities, those who are excluded from the banking system and small businesses.”304

402. In evidence to the Committee, Jeremy Peat posed a series of questions relating to the types of institution that could be developed and suggested that it was important to consider whether the environment was one in which they could flourish—

“I am saying that I would love alternative models of banks to emerge. Airdrie Savings Bank is an example of a particular type—a co-operative banking and old building society model. Can such banks exist in a niche within the system? Can there be different models that address different markets in different ways, so that there is choice for consumers and customers? Can a sector be built up that is not dominated by two or three large players but has a number of players, some of which are …building on synergies, some of which build up from the bottom and some of which are elements of larger financial institutions?

“There is no reason why we should not have a proliferation of different types of players, making for a variety of choice, particularly for households and individuals but also for small businesses. We should consider whether, at the moment, we are encouraging and setting a context within which such a proliferation can thrive.”305

403. The Committee calls on the Scottish Government to explore how mutuals, cooperatives and credit unions can be further supported and local initiatives developed. In particular, the Scottish Government to seek to engage on development of regulation that would support this diversification.

Supporting investment management

404. The Committee wrote to the Scottish Public Pensions Authority and Scottish local authorities to ascertain whether Scottish investment managers were used in relation to public sector pension funds. The responses received showed strong evidence to the use of actuarial consultants and investment managers in Scotland. However, it was stressed that any contracts were tendered in accordance with the European Union public procurement regulations and that the key criteria in selecting companies was the likely financial return received on an investment. The Committee calls on public sector pension funds in Scotland to consider further how they can draw on the skills and success of investment managers in Scotland when taking investment decisions.

The accountancy profession

405. The Committee took evidence from representatives of the accountancy profession on its role in auditing the accounts of financial institutions. It notes that the profession has “gone through a significant strengthening of the accounting and audit regulatory system over the past few years”,306 but considers that the profession needs to further consider how it can add value to the auditing process. It does not believe that it is sufficient to argue that as “the audit is on the financial statements, which are historical records” that there “is an inherent limitation in financial reports and in the audit of those reports that we cannot get away from.”307

406. The Committee calls on the accountancy profession to be more rigorous in checking and questioning the information and data that its reports are based on.

Conclusion

407. To conclude, we believe that despite the problems that we have witnessed, our financial services sector can be reformed and can continue to play an important role in our economy and our society as a whole. The Committee wants to see our largest banks reformed and put back on a sustainable footing in terms of how they are run. We want to see a substantial increase in competition and in the diversity of players in this sector in Scotland. We also want to see the other more successful parts of the financial services sector supported and encouraged to flourish and grow. The Committee believes that there is a ‘once-in-a-generation’ chance for reform and we have set out our vision of some of the changes that are needed.

408. The Committee intends to maintain a watching brief on the financial sector in Scotland and urges the Scottish Government to do likewise. The financial crisis has shown the catastrophic effect that failure in the banking sector can have on the real economy and on individuals. The institutions of Parliament and Government must act to ensure that this crisis is not repeated.

ANNEXE A: EXTRACTS FROM THE MINUTES OF THE ECONOMY, ENERGY AND TOURISM COMMITTEE

22nd Meeting, 2009 (Session 3), Wednesday 9 September 2009

1. Decision on taking business in private: The Committee agreed to take item 8 in private.

8. The way forward for Scotland’s banking, building society and financial services sector - appointment of adviser: The Committee agreed to seek approval for the appointment of an adviser, a draft remit and person-specification and agreed a ranked list of candidates for the post of adviser in connection with its inquiry.

23rd Meeting, 2009 (Session 3), Wednesday 16 September

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Paul Chisnall, Executive Director, British Bankers' Association;

Adrian Coles, Director-General, The Building Societies Association;

Owen Kelly, Chief Executive, Scottish Financial Enterprise.

24th Meeting, 2009 (Session 3), Wednesday 23 September

An inquiry into the way forward for Scotland’s banking, building society andfinancial services sector inquiry: The Committee took evidence from—

Dr Andrew Goudie, Chief Economic Adviser, Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, and Margaret M McGrath, Financial Services Team Leader, Scottish Government.

25th Meeting, 2009 (Session 3), Wednesday 30 September

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Robert Peston, BBC Business Editor, BBC.

26th Meeting, 2009 (Session 3), Wednesday 7 October

1. Decision on taking business in private: The Committee decided to take item 4 in private.

4. The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee considered written evidence received for this inquiry and agreed a list of witnesses to invite to appear before the Committee.

28th Meeting, 2009 (Session 3), Wednesday 4 November

In attendance: Philip Augur (Adviser) (item 2)

The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Clive Maxwell, Senior Director, Services, and Alistair Mordaunt, Director, Mergers, Office of Fair Trading.

29th Meeting, 2009 (Session 3), Wednesday 11 November

In attendance: Philip Augar (Adviser) (item 2)

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Jeremy Peat, Director, David Hume Institute;

Tony Prestedge, Group Development Director, Alison Robb, Divisional Director, Group Strategy & Planning, and Rudolf Heaf, Interim Managing Director at Dunfermline Building Society, Nationwide Building Society.

30th Meeting, 2009 (Session 3), Wednesday 18 November

In attendance: Philip Augar (Adviser)

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Irmfried Schwimann, Director for Markets and Cases III - Financial Services, DG Competition, European Commission;

Michael Kirkwood, Board Member, Sam Woods, Chief Operating Officer, and John Compton, Head of Market Investments, UK Financial Investments Ltd.

31st Meeting, 2009 (Session 3), Wednesday 25 November

In attendance: Philip Augar (Adviser)

An inquiry into the way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Stephen Hester, Group Chief Executive, and Andrew McLaughlin, Group Chief Economist, The Royal Bank of Scotland Group;

Gillian Tett, Assistant Editor of the Financial Times, in charge of global markets.

32nd Meeting, 2009 (Session 3), Wednesday 2 December

In attendance: Philip Augar (Adviser) (item 1)

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Archie G. Kane, Group Executive Director, Insurance and Scotland, Lloyds Banking Group.

33rd Meeting, 2009 (Session 3), Wednesday 9 December

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

John Rendall, CEO Scotland, HSBC;

Jon Pain, Managing Director Supervision, Financial Services Authority.

34th Meeting, 2009 (Session 3), Wednesday 16 December

The way forward for Scotland’s banking, building society and financial services sector inquiry: The Committee took evidence from—

Benny Higgins, Chief Executive Officer, Tesco Bank;

David Thorburn, Executive Director and Chief Operating Officer, Clydesdale Bank.

1st Meeting, 2010 (Session 3), Wednesday 6 January

In attendance: Philip Augar (Adviser)

The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Rt Hon John McFall MP, Chairman, House of Commons Treasury Committee, and Eve Samson, Clerk of the Treasury Committee, House of Commons.

2nd Meeting, 2010 (Session 3), Wednesday 13 January

In attendance: Philip Augar (Adviser) (item 6)

The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

David Nish, Group Chief Executive, Standard Life;

Maggie Craig, Acting Director General, Association of British Insurers.

3rd Meeting, 2010 (Session 3), Wednesday 20 January

In attendance: Philip Augar (Adviser) (items 2 & 4)

1. Decision on taking business in private: The Committee decided to take item 4 in private and all future items relating to its draft report on the way forward for Scotland's banking, building society and financial services sector in private.

2. The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Steve Smit, Head of State Street Investor Services UKMEA and Global Markets EMEA.

4. The way forward for Scotland’s banking, building society and financial services sector: The Committee considered its approach to the inquiry report with its adviser, Philip Augar.

4th Meeting, 2010 (Session 3), Wednesday 27 January

The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Bryan Johnston, Divisional Director, Brewin Dolphin;

Stephen Boyd, Assistant Secretary, Scottish Trades Union Congress;

Wendy Dunsmore, National Secretary, and Rob MacGregor, National (UK) Officer for Finance, Unite the Union;

Colin Borland, Public Affairs Manager, Federation of Small Businesses, and Brian Scott, Assistant National Secretary, Unite the Union, representing the Post Bank Coalition.

5th Meeting, 2010 (Session 3), Wednesday 3 February

The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Angus Tulloch, and Stuart Paul, Investment Managers;

Richard Martin, Head of Financial Reporting, The Association of Chartered Certified Accountants;

Bruce Cartwright, Chairman, Technical Policy Board, The Institute of Chartered Accountants of Scotland, Partner & Head of Recovery Services PricewaterhouseCoopers;

David Wood, Executive Director, Technical Policy, The Institute of Chartered Accountants of Scotland;

Iain Coke, Head of Financial Services Faculty, Institute of Chartered Accountants in England and Wales;

Richard J. Hunter, Group Managing Director for Corporate Ratings Europe, Middle East, Africa and Asia, Fitch Ratings.

6th Meeting, 2010 (Session 3), Wednesday 10 February

The way forward for Scotland's banking, building society and financial services sector: The Committee took evidence from—

Jim Watson, Chairman, and Gordon McGuinness, Member, Financial Sector Jobs Task Force;

Mark Tennant, Industry Deputy Chair, FiSAB;

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth, David Wilson, Director of Enterprise, Energy and Tourism, and Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, Scottish Government.

7th Meeting, 2010 (Session 3), Wednesday 24 February

In attendance: Philip Augar (Adviser) (item 2)

1. The way forward for Scotland’s banking, building society and financial services sector: The Committee took evidence from—

Willie Watt, Chief Executive, Martin Currie Investments Management Ltd.

2. The way forward for Scotland’s banking, building society and financial services sector (in private): The Committee considered a draft of its report.

8th Meeting, 2010 (Session 3), Wednesday 3 March

3. The way forward for Scotland’s banking, building society and financial services sector (in private): The Committee considered a draft report. Various changes were agreed to (one by division).

9th Meeting, 2010 (Session 3), Wednesday 10 March

6. The way forward for Scotland’s banking, building society and financial services sector (in private): The Committee considered a draft report.

10th Meeting, 2010 (Session 3), Wednesday 17 March

3. The way forward for Scotland’s banking, building society and financial services sector (in private): The Committee considered and agreed its draft report.

ANNEXE B – ORAL EVIDENCE AND ASSOCIATED WRITTEN EVIDENCE

The Committee took oral evidence from the witnesses listed below on the dates shown. Some of these witnesses provided written evidence specific to the meetings in question; some also provided supplementary written evidence afterwards. Oral evidence can be found in the Official Report of the committee meetings in question; written evidence specific to each meeting can be accessed from the links below (from the website version of this report). All other committee evidence submitted in response the Call for Evidence can be found in Annexe C & D.

23rd Meeting, 2009 (Session 3), Wednesday 16 September 2009

Oral Evidence

Owen Kelly, Chief Executive, Scottish Financial Enterprise;

Paul Chisnall, Executive Director of Financial Policy and Operations, British Bankers’ Association;

Adrian Coles, Director General, The Building Societies Association.

24th Meeting, 2009 (Session 3), Wednesday 23 September 2009

Oral Evidence

Dr Andrew Goudie, Chief Economic Adviser, Scottish Government;

Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, Scottish Government;

Margaret M McGrath, Financial Services Team Leader, Scottish Government.

Supplementary Evidence

Scottish Government

Scottish Government

25th Meeting, 2009 (Session 3), Wednesday 30 September 2009

Oral Evidence

Robert Peston, BBC Business Editor, BBC.

28th Meeting, 2009 (Session 3), Wednesday 4 November 2009

Oral Evidence

Clive Maxwell, Senior Director, Services, Office of Fair Trading;

Alistair Mordaunt, Director, Mergers, Office of Fair Trading.

Supplementary Evidence

Office of Fair Trading

29th Meeting, 2009 (Session 3), Wednesday 11 November 2009

Oral Evidence

Jeremy Peat, Director, David Hume Institute;

Tony Prestedge, Group Development Director, Nationwide Building Society;

Alison Robb, Divisional Director, Group Strategy & Planning, Nationwide Building Society;

Rudolf Heaf, Interim Managing Director at Dunfermline Building Scociety, Nationwide Building Society.

30th Meeting, 2009 (Session 3), Wednesday 18 November 2009

Oral Evidence

Irmfried Schwimann, Director for Markets and Cases III – Financial Services, DG Competition, European Commission;

Michael Kirkwood, Board Member, UK Financial Investments Ltd;

Sam Woods, Chief Operating Officer, UK Financial Investments Ltd;

John Compton, Head of Market Investments, UK Financial Investments Ltd.

31st Meeting, 2009 (Session 3), Wednesday 25 November 2009

Oral Evidence

Stephen Hester, Chief Executrive, The Royal Bank of Scotland Group;

Andrew McLaughlin, Group Chief Economist, The Royal Bank of Scotland Group.

32nd Meeting, 2009 (Session 3), Wednesday 2 December 2009

Oral Evidence

Archie G. Kane, Group Executive Director, Insurance and Scotland, Lloyds Banking Group.

33rd Meeting, 2009 (Session 3), Wednesday 9 December 2009

Oral Evidence

John Rendall, CEO Scotland, HSBC;

Jon Pain, Managing Director Supervision, Financial Services Authority.

Supplementary Evidence

Financial Services Authority

34th Meeting, 2009 (Session 3), Wednesday 16 December 2009

Oral Evidence

Benny Higgins, Chief Executive Officer, Tesco Bank;

David Thorburn, Executive Director and Chief Operating Officer, Clydesdale Bank.

Supplementary Evidence

Clydesdale Bank

1st Meeting, 2010 (Session 3), Wednesday 6 January 2010

Oral Evidence

Rt Hon John McFall, Chairman, House of Commons Treasury Committee;

Eve Samson, Clerk of the Treasury Committee, House of Commons.

2nd Meeting, 2010 (Session 3), Wednesday 13 January 2010

Oral Evidence

David Nish, Group Chief Executive, Standard Life;

Maggie Craig, Acting Director General, Association of British Insurers.

3rd Meeting, 2010 (Session 3), Wednesday 20 January 2010

Oral Evidence

Steve Smit, Head of State Street Investor Services UKMEA and Global Markets EMEA.

4th Meeting, 2010 (Session 3), Wednesday 27 January 2010

Oral Evidence

Bryan Johnston, Divisional Director, Brewin Dolphin;

Stephen Boyd, Assistant Secretary, Scottish Trades Union Congress;

Wendy Dunsmore, National Secretary, and Rob MacGregor, National (UK) Officer for Finance, Unite the Union;

Colin Borland, Public Affairs Manager, Federation of Small Businesses, representing the Post Bank Coalition;

Brian Scott, Assistant National Secretary, Unite the Union, representing the Post Bank Coalition.

5th Meeting, 2010 (Session 3), Wednesday 3 February 2010

Oral Evidence

Angus Tulloch, Investment Manager;

Stuart Paul, Investment Manager;

Richard Martin, Head of Financial Reporting, The Association of Chartered Certified Accountants;

Bruce Cartwright, Chairman, Technical Policy Board, The Institute of Chartered Accountants of Scotland, Partner & Head of Recovery Services PricewaterhouseCoopers;

David Wood, Executive Director, Technical Policy, The Institute of Chartered Accountants of Scotland;

Iain Coke, Head of Finance Faculty, Institute of Chartered Accountants in England and Wales;

Richard J. Hunter, Group Managing Director for Corporate Ratings Europe, Middle East, Africa and Aisa, Fitch Ratings.

Supplementary Evidence

Angus Tulloch and David Gait

Stuart Paul and Angus Tulloch

6th Meeting, 2010 (Session 3), Wednesday 10 February 2010

Oral Evidence

Jim Watson, Chairman, Financial Sector Jobs Task Force;

Gordon McGuinness, Member, Financial Sector Jobs Task Force;

Mark Tennant, Industry Deputy Chair, FiSAB;

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth, Scottish Government;

David Wilson, Director of Enterprise, Energy and Tourism, Scottish Government;

Dr Gary Gillespie, Deputy Director, Office of the Chief Economic Adviser, Scottish Government.

Supplementary Evidence

Scottish Government

7th Meeting, 2010 (Session 3), Wednesday 24 February 2010

Oral Evidence

Willie Watt, Chief Executive, Martin Currie Investments Management Ltd.

Supplementary Evidence

Martin Currie

ANNEXE C – WRITTEN EVIDENC

Association of British Credit Unions Ltd (ABCUL) Scotland
Association of British Insurers
Association of Chartered Certified Accountants Scotland (ACCA)
Barclays
Botfield, Colin R
British Bankers Association
Building Societies Association
CBI Scotland
Chartered Institute of Bankers in Scotland (CIOBS)
Clydesdale Bank
Co-operation and Mutuality Scotland
Council of Mortgage Lenders
Developing Strathclyde Ltd (DSL)
European Commission, The
Federation of Small Businesses (FSB)
Fife Chamber of Commerce
Financial Services Authority, The
Friends of the Earth, Banktrak, People and Planet and the World Development Movement
Highlands and Islands Enterprise
HM Treasury
Institute of Chartered Accountants in England and Wales (ICAEW) Members in Scotland (IMS)
Institute of Chartered Accountants for Scotland, The
Investment Management Association
Lloyds Banking Group
Office of Fair Trading, The
Post Bank Coalition, The
Reynolds, James
Royal Bank of Scotland Group
Scottish Building Federation, The
Scottish Council for Development and Industry
Scottish Council for Voluntary Organisations
Scottish Enterprise
Scottish Financial Enterprise
Scottish Government
Scottish Social Enterprise Coalition
Stoops, Stephen
Scottish Trade Union Congress (STUC)
Standard Life plc
Tesco
UK Financial Investments Ltd
Unite the Union
Virgin Money

ANNEXE D: ADDITIONAL WRITTEN EVIDENCE

Aberdeen City Council
City of Edinburgh Council
Developing Strathclyde Ltd (DSL)
Dundee Council
Falkirk Council
Financial Investments Ltd
Highland Council
HM Treasury
Lloyds Banking Group
Royal Bank of Scotland
Scottish Borders Council
Scottish Public Pensions Agency
Standard Life
Strathclyde Pension Fund


Footnotes:

1 House of Commons Scottish Affairs Committee (2010). Banking in Scotland, Second Report of Session 2009-10. HC 70-1.

2 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2621.

3 Adam Smith’s chapter on banking in Wealth Of Nations, ‘Of Money considered as a particular Branch of the general Stock of the Society, or of the Expense of maintaining the National Capital’ (Book II, chapter ii, pp 286-320; Oxford University Press, 1976).

4 Scottish Government (2009). Gross Domestic Product for Scotland Q1. Available at:http://www.scotland.gov.uk/Publications/2009/07/GDP2009Q1/Q/Page/2. [Accessed 15 March 2010].

5 Office for National Statistics (2009). Annual Business Inquiry. Available at: https://www.nomisweb.co.uk/Default.asp [Accessed 26 August 2009].

6 Scottish Financial Enterprise. Written submission to the Economy, Energy and Tourism Committee.

7 Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010], p.3.

8Scottish Government (2008). Scotland – Operational Excellence. Available at: http://www.scotland.gov.uk/Resource/Doc/919/0067797.pdf [Accessed 15 March 2010].

9 Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010].

10 Office for National Statistics. Annual Survey of Hours and Earnings 2009. Available at: http://www.statistics.gov.uk/statBase/product.asp?vlnk=15313. [Accessed 15 March 2020].

11 Scottish Enterprise (2009). The Financial Services Industry in Scotland. Available at: http://www.scottish-enterprise.com/financial-background. [Accessed 15 March 2010].

12 Scottish Government (2009). Input – Output Tables 2004. Available at: http://www.scotland.gov.uk/Topics/Statistics/Browse/Economy/Input-Output/IOAllFiles2004 [Accessed 15 March 2010].

13 In Figure 4, “intermediation” refers primarily to asset servicing. Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010].

14 Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010].

15 RBS (2007). Group Chief Executive’s Review. Available at:
http://www.rbs.com/microsites/gra2007/gce_review/index.asp [Accessed 15 March 2010].

16 In 2008, RBS was ranked the first bank in the world in terms of its total assets and fourth in terms of its Tier 1 Capital. The Banker (2009)

17 HBOS plc (2007). Annual Report and Accounts 2007, p.5. Available at: http://www.lloydsbankinggroup.com/investors/financial_performance/company_results_hbos.asp. [Accessed 15 March 2010].

18 HBOS plc (2007). Annual Report and Accounts 2007, p.13. Available at: http://www.lloydsbankinggroup.com/investors/financial_performance/company_results_hbos.asp. [Accessed 15 March 2010].

19 HBOS plc (2007). Annual Report and Accounts 2007, p.13. Available at: http://www.lloydsbankinggroup.com/investors/financial_performance/company_results_hbos.asp. [Accessed 15 March 2010].

20 Office of Fair Trading (2008). Anticipated acquisition by Lloyds TSB plc of HBOS plc. Available at: http://www.oft.gov.uk/shared_oft/press_release_attachments/LLloydstsb.pdf. [Accessed 15 March 2010].

21 Competition Commission (2000). The supply of banking services by clearing banks to small and medium-sized enterprises: A report on the supply of banking services by clearing banks to small and medium-sized enterprises within the UK - Volumes 1, 2, 3 and 4. Available at: http://www.competition-commission.org.uk/rep_pub/reports/2002/462banks.htm [Accessed 15 March 2010].

22 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 4 November 2010, Col 2603.

23 Standard Life plc (2007). Annual Report and Accounts 2007. Available at: http://ukgroup.standardlife.com/html/annual_report/ara2007/index.html. [Accessed 15 March 2010].

24 Scotland Act 1998, Schedule 5, Part II, Specific Reservations.

25 Financial Services Authority. Written submission to the Economy, Energy and Tourism Committee.

26 Financial Services Authority. Written submission to the Economy, Energy and Tourism Committee..

27 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2635.

28 Financial Services Authority (2009). The Turner Review: a regulatory response to the global banking crisis, p.85. Available at: http://www.fsa.gov.uk/Pages/Library/Corporate/turner/index.shtml [Accessed 15 March 2010].

29 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2459.

30 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2459.

31 Fannie Mae is the name given to the US Federal National Mortgage Association. Freddie Mac is the name given to the US Federal Home Loan Mortgage Corporation.

32 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2660.

33 In January 2010, Iceland’s President, Olafur Ragnar Grimsson, decided to block legislation that would have repaid £2.3 billion to the UK to repay expenditures by the Government to compensate citizens who lost money in the collapse of Internet bank Icesave. In a referendum on 6 March 2009, over 90 per cent of those voting voted to reject legislation which would have reimbursed the UK and Dutch Governments for funds that they paid out to savers in the Icesave Bank.

34 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2463.

35 Scottish Parliament Economy, Energy and Tourism Committee. Official Report 23 September 2009, Col 2408.

36 HM Treasury (2008). Financial support to the banking industry. Available at: http://www.hm-treasury.gov.uk/press_100_08.htm [Accessed 15 March 2010].

37 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2010, Col 2664.

38 HM Treasury (2008). Treasury statement on financial support to the banking industry. Available at: http://www.hm-treasury.gov.uk/press_105_08.htm. [Accessed 15 March 2010].

39 BBC News (2008). UK banks receive £37billion bail-out. Available at: http://news.bbc.co.uk/1/hi/business/7666570.stm. [Accessed 15 March 2010].

40 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2624.

41 In early March 2010, the European Commission had not yet published the full versions of these decisions. However, the key information contained in the decisions had been released by the two banks concerned.

42 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2670.

43 Office for National Statistics. Available at: http://www.statistics.gov.uk/cci/nugget.asp?id=192. [Accessed 15 March 2010].

44 Scottish Government (2010). Gross Domestic Product (GDP) for Scotland 3rd Quarter of 2009 Available at http://www.scotland.gov.uk/Publications/2010/01/GDP2009Q3 [Accessed 15 March 2010].

45 Office for National Statistics Nomis: Official Labour Market Statistics. https://www.nomisweb.co.uk/Default.asp

46 Scottish Parliament Economy, Energy and Tourism Committee. Official Report,11 November 2009, Cols 2619-20.

47 Scottish Government (2009). SME Access to Finance 2009 Report, p.6. Available at http://www.scotland.gov.uk/Topics/Economy/access-finance. [Accessed 15 March 2010]

48 Scottish Government (2010). SME Access to Finance Survey November 2009 Report, p.4. Available at: http://www.scotland.gov.uk/Topics/Economy/access-finance. [Accessed 15 March 2010].

49 Institute of Directors Press Release. Banking sector’s position on business lending contradicted by new evidence, says IoD. Available at http://press.iod.com/2010/02/16/banking-sector%E2%80%99s-position-on-business-lending-contradicted-by-new-evidence-says-iod/. [Accessed 15 March 2010].

50 National Audit Office. (2009). News Release. Maintaining financial stability across the United Kingdom’s banking system. Available at: http://www.nao.org.uk/publications/0910/uk_banking_system.aspx. [Accessed 15 March 2010].

51 The National Audit Office notes that £2.5 billion of the initial preference shares in LBG were subsequently redeemed. National Audit Office (2009). Maintaining Financial Stability Across the United Kingdom’s banking system, Summary, p.5. Available at: http://www.nao.org.uk/publications/0910/uk_banking_system.aspx. [Accessed 15 March 2010].

52 National Audit Office (2009). Maintaining Financial Stability Across the United Kingdom’s banking system, Summary, p.5. Available at: http://www.nao.org.uk/publications/0910/uk_banking_system.aspx. [Accessed 15 March 2010].

53 Scottish Parliament Information Centre (2010) Banking inquiry: additional material supplied in response to Members Enquiries. Available at: http://www.scottish.parliament.uk/s3/committees/eet/papers-10/eep10-06.pdf [Accessed 15 March 2010].

54 Scottish GDP in 2008 is estimated at £144 billion, assuming an 83 per cent geographic share of North Sea Oil and gas. The figure for UK GDP is £1448 billion.

55 International Monetary Fund (2010) Global Financial Stability Report. A Report by the Monetary and Capital Markets Department on Market Developments and Issues. Available at: http://www.imf.org/external/pubs/ft/GFSR/index.htm [Accessed 15 March 2020].

56 HM Treasury (2009). Pre-Budget Report 2009: Securing the recovery: growth and opportunity. Available at http://www.hm-treasury.gov.uk/prebud_pbr09_repindex.htm. [Accessed 15 March 2010].

57 Scottish Government. Financial and Business Services Key Sector Report. February 2008, p.6.

58 Mervyn King, Governor of the Bank of England, Speech to Scottish Business organisations, Edinburgh, 20 October 2009, p.3. Available at: http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf [Accessed 15 March 2010].

59 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2671.

60 National Audit Office News Release. Maintaining financial stability across the United Kingdom’s banking system Available at:http://www.nao.org.uk/publications/0910/uk_banking_system.aspx [Accessed 15 March 2010].

61 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2458.

62 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2750.

63 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 September 2009, Col 2369.

64 Angela Knight CBE, Chief Executive, British Bankers Association 2007. Available at:
http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=9652 [Accessed 15 March 2010].

65 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 23 September 2009, Col 2460.

66 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2757.

67 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3063.

68 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2745.

69 International Monetary Fund Global Financial Stability Report, April 2006, quoted in the Financial Services Authority (2009). The Turner Review: a regulatory response to the global banking crisis, p.85. Available at: http://www.fsa.gov.uk/Pages/Library/Corporate/turner/index.shtml [Accessed 15 March 2010].

70 HM Treasury. Written submission to the Economy, Energy and Tourism Committee.

71 STUC. Written submission to the Economy, Energy and Tourism Committee.

72 STUC. Written submission to the Economy, Energy and Tourism Committee.

73 HM Treasury. Written submission to the Economy, Energy and Tourism Committee.

74 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November, Col 2758.

75 Financial Services Authority (2009). The Turner Review: a regulatory response to the global banking crisis, p.12. Available at: http://www.fsa.gov.uk/Pages/Library/Corporate/turner/index.shtml [Accessed 15 March 2010].

76 Scottish Parliament Economy, Energy and Tourism Committee. Official Report,11 November 2009, Col 2621.

77 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2745.

78 Office for National Statistics figures for January 2010 indicate that the UK trade gap in goods and services increased to £3.8 billion, compared with £2.6 billion in December 2009.

79 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2759.

80 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2759.

81 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2759.

82 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2454.

83 Scottish Parliament Information Centre (2010) Banking inquiry: additional material supplied in response to Members Enquiries. Available at: http://www.scottish.parliament.uk/s3/committees/eet/papers-10/eep10-06.pdf [Accessed 15 March 2010].

84 Scottish Parliament Information Centre (2010) Banking inquiry: additional material supplied in response to Members Enquiries. Available at: http://www.scottish.parliament.uk/s3/committees/eet/papers-10/eep10-06.pdf [Accessed 15 March 2010].

85 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3175.

86 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 6 January 2009, Col 2927.

87 Scottish Parliament Economy, Energy and Tourism Committee. Official Report,30 September 2009, Col 2459.

88 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 2744.

89 Scottish Parliament Economy, Energy and Tourism Committee. Official Report,27 January 2010, Col 2744.

90 HM Treasury. Written submission to the Economy, Energy and Tourism Committee.

91 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 September 2009, Col 2369.

92 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2652.

93 Financial Services Authority. Written submission to the Economy, Energy and Tourism Committee.

94 Financial Services Authority. Written submission to the Economy, Energy and Tourism Committee.

95 Office for National Statistics (2009). Financial Statistics. Available at: http://www.statistics.gov.uk/downloads/theme_economy/FinStats_Dec09.pdf. [Accessed 15 March 2010]. NB. Some prior years obtained through personal communication with ONS.

96 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3075.

97 The term leverage relates to techniques that can magnify returns or losses and is most commonly applied to the application of debt. It is also used to explain the way in which the structure of a collateralised debt obligation or another type of derivative can magnify investor exposure to price swings.

98 Mervyn King, Governor of the Bank of England, Speech to Scottish Business organisations, Edinburgh, 20 October 2009. Available at: http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf [Accessed 15 March 2010]

99 Financial Services Authority. Written submission to the Economy, Energy and Tourism Committee.

100 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 6 January 2010, Col 2929.

101 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 3453.

102 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2846.

103 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Cols 2454-5.

104 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2758.

105 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2697.

106 Scottish Parliament Economy, Energy and Tourism Committee. Official Report,18 November 2009 , Col 2700.

107 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2666.

108 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 6 January 2010, Col 2928.

109 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 6 January 2010, Col 2928.

110 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2627.

111 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2627.

112 Decision by Lord Mandelson, the Secretary of State for Business, not to refer to the Competition Commission the merger between Lloyds TSB Group plc and HBOS plc under Section 45 of the Enterprise Act 2002 date 31 October 2008. Available at: http://www.berr.gov.uk/files/file48745.pdf. [Accessed 15 March, 2010].

113 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2450.

114 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2793.

115 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2774.

116 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2793.

117 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2778.

118 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2466.

119 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col. 2754.

120 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2773.

121 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 September 2008, Col 1027.

122 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 September 2008, Cols 1026-7.

123 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 September 2008, Cols 1026-7.

124 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2648.

125 Scottish Affairs Committee (2009). Fifth Report 2008-9 Dunfermline Building Society, paragraph 45. Available at: http://www.publications.parliament.uk/pa/cm200809/cmselect/cmscotaf/548/54802.htm [Accessed March 2010].

126 Mervyn King, Governor of the Bank of England, Bank’s casino activities must be curbed, The Herald, 21 October 2009. Available at: http://www.heraldscotland.com/business/analysis/exclusive-comment-by-mervyn-king-banks-casino-activities-must-be-curbed-1.927501 [Accessed 15 March 2010]

127 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3223.

128 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3069.

129 Financial Services Authority (2009). Discussion Paper DP09/2: A regulatory response to the global banking crisis. http://www.fsa.gov.uk/pages/Library/Policy/DP/2009/09_02.shtml

130 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2849.

131 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2846.

132 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 September 2009, Col 2357.

133 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2683.

134 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 20 January 2010, Col 3035.

135 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2734.

136 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2853.

137 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2853.

138 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 6 January 2010, Col 2943.

139 Mervyn King, Governor of the Bank of England, Speech to Scottish Business organisations, Edinburgh, 20 October 2009, p.3. Available at: http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf [Accessed 15 March 2010]

140 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 13 January 2010, Cols 3016-7.

141 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3077.

142 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3122.

143 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 13 January 2010, Col 3000.

144 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2638.

145 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3127.

146 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3127.

147 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 13 January 2010, Col 3003.

148 Which? (2009). The banking reform one year on.

149 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 13 January 2010, Col 3012.

150 Financial Services Authority (2009). The Turner Review: a regulatory response to the global banking crisis, p.87. Available at: http://www.fsa.gov.uk/Pages/Library/Corporate/turner/index.shtml [Accessed 15 March 2010]..

151 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2463.

152 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 30 September 2009, Col 2463.

153 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2773.

154 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 September 2009, Col 2362.

155 UK Government (2008). The banking support measures in detail. Available at: http://www.direct.gov.uk/en/Nl1/Newsroom/DG_172296 [Accessed 15 March 2010].

156 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 23 September 2009, Col 2408.

157 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 23 September 2009, Col 2404.

158 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 23 September 2009, Col 2408.

159 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 23 September 2009, Col 2410.

160 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3143.

161 Fife Chamber of Commerce. Written submission to the Economy, Energy and Tourism Committee.

162 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3143.

163 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3144.

164 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Cols 2729-30.

165 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2730.

166 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2730.

167 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2782.

168 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2783.

169 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2782.

170 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2783.

171 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2783-4.

172 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2906.

173 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2912.

174 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2835.

175 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2835.

176 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2826.

177 Barclays Bank. Written submission to the Economy, Energy and Tourism Committee.

178 Barclays Bank. Written submission to the Economy, Energy and Tourism Committee.

179 Barclays Bank. Written submission to the Economy, Energy and Tourism Committee.

180 Scottish Parliament Economy, Energy and Tourism Committee 6th Report, 2008 (Session 3) Growing Pains - can we achieve a 50% growth in tourist revenue by 2015? (SP141). Scottish Parliament Economy, Energy and Tourism Committee 7th Report, 2009 (Session 3) Determining and delivering on Scotland's energy future (SP 313).

181 Economy, Energy and Tourism Committee, 6th Report, 2008 (Session 3), Growing Pains - can we achieve a 50 per cent growth in tourist revenue by 2015?, (SP141), paragraph 242.

182 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3194.

183 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3194.

184 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2724.

185 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col l 2724.

186 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2739.

187 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2790.

188 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2757.

189 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3229.

190 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3229.

191 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3205.

192 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3205.

193 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January February 2010, Col 3070.

194 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2905.

195 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 13 January 2010, Col 2995.

196 Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010], p.8.

197 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 September 2009, Col 2373.

198 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 20 January 2010, Col 3027.

199 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 2785.

200 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2785.

201 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 2994.

202 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 2996.

203 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 2996.

204 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 2995.

205 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3004.

206 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3007.

207 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 February 2010, Col 3240.

208 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Cols 3052-3.

209 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3118.

210 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3118.

211 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 February 2010, Col 3240.

212 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 February 2010, Col 3240.

213 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3121.

214 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 February 2010, Col 3240.

215 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 20 January 2010, Col 3027.

216 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 20 January 2010, Col 3032.

217 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 3902.

218 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 3902.

219 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 3902.

220 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2906.

221 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2906.

222 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2920.

223 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2920.

224 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2835.

225 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2836.

226 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2896.

227 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 16 December 2009, Col 2900.

228 Virgin Money. Written submission to the Economy, Energy and Tourism Committee.

229 Virgin Money. Written submission to the Economy, Energy and Tourism Committee.

230 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2640.

231 Co-operation and Mutuality Scotland. Written submission to the Economy, Energy and Tourism Committee.

232 Co-operation and Mutuality Scotland. Written submission to the Economy, Energy and Tourism Committee.

233 Cooperation and Mutuality Scotland. Written submission to the Economy, Energy and Tourism Committee.

234 Cooperation and Mutuality Scotland. Written submission to the Economy, Energy and Tourism Committee.

235 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2660.

236 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2661.

237 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2660.

238 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2662.

239 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2662.

240 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2670.

241 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2857.

242 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2857.

243 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 9 December 2009, Col 2858.

244 HM Treasury. Written submission to the Economy, Energy and Tourism Committee.

245 HM Treasury. Establishment of UK Financial Investments Limited (UKFI). Available at:
http://www.hm-treasury.gov.uk/uk_financial_investments_limited.htm. [Accessed 15 March 2010].

246 UK Financial Investments Ltd (2009) Shareholder Relationship Framework Document, revised version 13 July 2009 Available at: http://www.hm-treasury.gov.uk/d/ukfi_framework.pdf. [Accessed 15 March 2010].

247 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2702.

248 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2688.

249 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Cols 2702-3.

250 RBS press release. 2009 Annual Results. RBS Annual Results are available at: http://www.rbs.com/media/media-information.ashx [Accessed 15 March 2010].

251 RBS press release. 2009 Annual Results. RBS Annual Results are available at: http://www.rbs.com/media/media-information.ashx [Accessed 15 March 2010].

252 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2722.

253 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2723.

254 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2693.

255 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2691.

256 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2692.

257 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Col 2692.

258 HM Treasury. Written submission to the Economy, Energy and Tourism Committee.

259 European Commission (2009) Press release IP/09/1915. State Aid: Commission approves impaired asset relief measure and restructuring plan of Royal Bank of Scotland. Available at: http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/1915. [Accessed 15 March 2010].

260 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2625.

261 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2729.

262 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2729.

263 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2719.

264 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Cols 2625-6.

265 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 18 November 2009, Cols 2692-3.

266 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2625.

267 Lloyds Banking Group. Group Chief Executive’s Statement 2009. Available at: http://www.lloydsbankinggroup.com/media1/eric_statement.asp [Accessed 15 March 2020].

268 Lloyds Banking Group. Group Chief Executive’s Statement 2009. Available at: http://www.lloydsbankinggroup.com/media1/eric_statement.asp [Accessed 15 March 2020].

269 BBC Business news report (2008). Lloyds TSB's HBOS deal is cleared. Available at: http://news.bbc.co.uk/1/hi/business/7702809.stm. [Accessed 15 March 2010].

270 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 4 November 2009, Col 2601.

271 Scottish Government. Supplementary written evidence to the Economy, Energy and Tourism Committee.

272 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2774.

273 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2798.

274 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2770.

275 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 2 December 2009, Col 2781.

276 This paragraph was agreed to by division, For: Wendy Alexander, Gavin Brown, Marilyn Livingston, Lewis Macdonald and Iain Smith. Against: Rob Gibson, Christopher Harvie and Stuart McMillan.

277 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3200.

278 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3200.

279 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3193.

280 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3194.

281 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3200.

282 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3200.

283 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3201.

284 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3215.

285 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3215.

286 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3226.

287 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3227.

288 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3227.

Scottish Executive (20005). Strategy for the Financial Services Industry in Scotland. Available at: http://www.scotland.gov.uk/Publications/2005/03/20865/54747 [Accessed 15 March 2010].

289 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3189.

290 In early 2010, the membership of FiSAB was: Rt. Hon Alex Salmond, MP, MSP, First Minister of Scotland (Chair); John Swinney, MSP, Cabinet Secretary for Finance and Sustainable Growth; Jim Mather, MSP, Minister for Enterprise, Energy and Tourism; Mark Tennant, Deputy Industry Chair - JP Morgan SFE Chair; Ian Ferguson – Aviva; Martin Gilbert - Aberdeen Asset Management; Benny Higgins - Tesco Bank; Archie Kane - Lloyds Banking Group; Tim Keaney - Bank of New York Mellon; Andrew McLaughlin - Royal Bank of Scotland; John Rendall – HSBC; Magnus Swanson - Maclay, Murray & Spens; Ben Thomson - Noble Group; Otto Thoresen - AEGON UK; Margaret Wallace - Morgan Stanley; Rob MacGregor - Unite the Union; Professor Anton Muscatelli - University of Glasgow; Lena Wilson - Scottish Enterprise; David Wilson - Scottish Government; and an HM Treasury observer.

291 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3081.

292 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Cols 3200-1.

293 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3219.

294 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3191.

295 Virgin Money. Written submission to the Economy, Energy and Tourism Committee.

296 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3219

297 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 10 February 2010, Col 3220.

298 Scottish Government. Written submission to the Economy, Energy and Tourism Committee.

299 Scottish Government (2010). Financial and Business Services Key Sector Report. Available at: http://www.scotland.gov.uk/Publications/2010/02/15090915/0. [Accessed 15 March 2010], p.15.

300 Scottish Government. Written submission to the Economy, Energy and Tourism Committee.

301 Scottish Government. Written submission to the Economy, Energy and Tourism Committee.

302 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 24 February 2010, Col 3254.

303 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 25 November 2009, Col 2761.

304 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 27 January 2010, Col 3096.

305 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 11 November 2009, Col 2638.

306 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3148.

307 Scottish Parliament Economy, Energy and Tourism Committee. Official Report, 3 February 2010, Col 3148.