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Page last updated at 08:49 GMT, Sunday, 19 October 2008 09:49 UK

Tougher rules for banks

On Sunday 19 October Sophie Rayworth interviewed Hector Sants, Financial Services Authority and Sir Brian Pitman, former Chairman of Lloyds Bank

Please note 'The Andrew Marr Show' must be credited if any part of this transcript is used.

The Chief Executive of the FSA warns the city watchdog will be 'more robust' on risk-taking; but says 'it's not for us to be a pay-regulator' .

Hector Sants
Hector Sants, Financial Services Authority

SOPHIE: Now there are two contradictory things going on for the government: on the political front, Gordon Brown's standing is certainly on the up; on the economic front, the outlook is dire.

House prices have slumped over the past year.

Figures to be released later this week are expected to show another fall in economic growth.

The decline is pushing unemployment sharply up.

Some are predicting 2 million unemployed by Christmas, and that will mean higher welfare bills adding to the growing deficit.

No wonder stock markets are in turmoil with share values falling dramatically in London, New York and Tokyo in the past few weeks.

Billions may have been poured into the banks by desperate governments in America and Europe, but there is no indication yet that these emergency measures have turned the tide.

Now in a moment I will be asking the newly titled Lord Mandelson what more the government can do to protect British jobs and shore up British business.

First though, a word with one of the key regulators Hector Sants who is Chief Executive of the Financial Services Authority and a very rare chance to talk to a top banker.

Sir Brian Pitman who was at Lloyds Bank for nearly 50 years is one of the few at the helm of the banking industry who's been prepared to put his head above the parapet.

Good morning to both of you. Sir Brian, first of all. You are a bit of a rare species at the moment. I mean bankers have been noticeably absent in public interviews.

BRIAN PITMAN: Well I don't know why that is. I mean we've been in a much worse position than we are today. People are getting unbelievably gloomy. But I've been around long enough to remember the 70s when we had to have the IMF. We had a three day working week, we had candles in rooms, we couldn't get home by train. We're not going to have that.

Sir Brian Pitman
Sir Brian Pitman, former Chairman of Lloyds Bank

SOPHIE: Do you think it...

BRIAN PITMAN: We got out of it. The market came back and we got out of it.

SOPHIE: Do you think they've been perhaps reluctant to be interviewed of late because everybody is saying bankers got us into this; it is the bankers' fault?

BRIAN PITMAN: Well the banks are partly to blame. There's no doubt about that.

SOPHIE: Partly to blame?

BRIAN PITMAN: Well not wholly to blame. Partly... and not all banks are in the same boot. I mean some banks have been much more reckless than others. What we've had is that some banks have been willing to lend 125% of a mortgage. If in fact you pay 100,000 for a house - if you can get one for that amount of money - and you lend them 125,000, don't be surprised if that leads to trouble. The repossessions will come from those banks mainly. If banks lent them 80% or 90%, they have a much better chance of not having to repossess.

SOPHIE: But the whole mess that we're in surely has been driven a lot by greed, fear as well, huge bonuses?

BRIAN PITMAN: Yes, I chaired a survey two years ago about why do companies fail. It was a very interesting survey - for all over the world. The main reason was one word: hubris - overconfidence, a belief you can walk on water. And it's very difficult to control those sort of people. At the end of the day it's the chairman and chief executive who control that. Choose the right chairman and the right chief executive and you won't get into so much trouble.

SOPHIE: Do you think bonuses will now be cracked down on massively? Is it going to change forever the whole banking industry in that sense?

BRIAN PITMAN: Look bonuses have been based on increases in profit for most companies. In most companies you get a bonus if the company does well. If the companies' profits go down, you don't get the same bonus. I think that will happen in 2008. So without any interference, you're going to find a big adjustment to this.

SOPHIE: 17 billion pounds worth of bonuses were paid out last year and that was when all this was happening, wasn't it - the whole build up to this?

BRIAN PITMAN: A lot of bonuses were paid out last year. It's quite right, yes. We're living in a very competitive market, there's no question about that. Generally speaking, the bonuses are based on the corporate form - that's the performance of the company as a whole; your divisional performance; and your individual performance. Now the odds are that not many companies are going to make more profit in 2008 than they did in 2007, but many companies made more profit in 2007 than they did in 2006.

SOPHIE: Will the government's bailout of the banks work?

BRIAN PITMAN: It'll stop the rot. That's what it's done. I mean something had to be done in order to stop the rot. We were beginning to lose deposits out of major banks in the UK. And when the Irish introduced this guarantee for deposits, depositors were flowing out of the UK into Ireland and other places which had also guaranteed the deposits. But I believe the action that's been taken will stop the rot.

SOPHIE: Some of the banks have been reluctant obviously to take some of the money. Is it because they don't want the government stake in their businesses?

BRIAN PITMAN: I think there's been a different approach. In the States it's quite clear that they want to get them out of this as quickly as possible, so they've charged the banks 5% for preference shares. In Europe, they've charged them 12% for preference shares, so there's a totally different approach in my view between Europe and the States. Even in Switzerland, which is not part of the European Union, the penalty for the banks is much less than the burden put on the British banks and some of the continental banks.

SOPHIE: The key to all this obviously is going to be to get the banks to lend to each other again and then to us because at the moment they're just hoarding their cash even though they have access to this 50 billion pounds of taxpayers' money.

BRIAN PITMAN: Well 50 billion is not very much in relation to a trillion. That's what people have to learn. If we look at the world markets, over the past twenty years the markets have grown much faster than the national economies - much, much faster - so that governments think in terms of billions; the market thinks in terms of trillions. And this has been one of the great frustrations for politicians. They've found that the Bank of England has reduced the interest rate, but the interest rate has not come down for lending. The reason for this is that money's being provided by countries that have got the savings. We don't save enough in the Western world. We save a fraction of money in Britain, a fraction of money in America and, therefore, you depend upon somebody else to buy your bonds or to provide the money.

SOPHIE: Hector Sants from the Financial Services Authority, why did you not see this coming?

HECTOR SANTS: I think nobody saw the events that have transpired coming - no commentator, no major regulator. Everybody knew that risk was being too cheaply priced - that was obvious, I think - and we warned about that and the Central Bank warned about that. But this collapse in confidence that then led to this collapse in liquidity is unprecedented. So yes it's right, nobody saw it coming but it was an event that has never occurred before.

SOPHIE: Alarm bells were ringing though. Come on! I mean everybody knew that we were borrowing huge amounts of money, we were being offered huge loans, and nobody seemed to be worried about that, putting a stop to it.

HECTOR SANTS: The risk was clearly wrongly priced and I think everybody did see that. And you know, as Brian has said, I think overall society as a whole, the system as a whole was overheated and people were enjoying the benefits of that overheating and people in the wider community were reluctant to say, 'Look, you know this is a party. It can't go on forever'.

SOPHIE: Was that you though? I mean that was your job. You as the FSA are supposed to be in there regulating the banks and keeping the levels, keeping the lid on. I mean were you reluctant to go in and say, 'Stop the party'?

HECTOR SANTS: We were clear about the risks the banks were running. That's absolutely written in stone that we were clear with our warnings. Having said that, we have acknowledged our share of responsibility. As Brian has said, at the end of the day the banks are run by their boards, but we absolutely acknowledge our share of responsibility because...

SOPHIE: Which is how big?

HECTOR SANTS: But could I be clear about what we acknowledge? We acknowledge that going into the downturn, going into the crisis, we should have worked more as a regulator with banks to ensure their management were properly focusing on the risks. Some of these banks - not all of the banks - some of these banks went into this downturn with a business model which has not been robust enough for the very particular circumstances.

SOPHIE: For the bad times, absolutely. But you should have...

HECTOR SANTS: But we have performed very, very well in the last fifteen months. I'm very proud of the FSA in the last fifteen months. We've done a good job.

SOPHIE RAWORTH: I think a lot of people will be really surprised to hear you say that. Why, why have you performed well when actually we've ended up here in extraordinary times?

HECTOR SANTS: As I say because the reality is the problems for these banks were what they were doing before the crisis hit, not what has happened in the crisis. The die was cast for these banks when they went into this crisis with their business models. We worked... We've done our utmost in the last fifteen months to minimise the difficulties which have then occurred - such as working through orderly solutions to some of the bank failures and working with the government to deliver this package over the weekend.

SOPHIE RAWORT: I mean to be fair, I mean you say you've minimised the difficulties, but look where we've ended up. I mean there are some people who say that the FSA, the people that you had employed and that you have been using to regulate the banks simply didn't understand the complexities of the banking system.

HECTOR SANTS: I think it's absolutely true at the origins of the FSA, which is ten years ago, we probably didn't have the right mix of market staff, people with business backgrounds. I myself have worked in banking for thirty years. Did not have the right mix of market professionalism and regulatory professionalism when it was set up. That has been addressed in the last twelve months.

SOPHIE RAWORTH: So the people you've been employing just weren't up to it effectively?

HECTOR SANTS: We did not have the right mix of skills. We didn't have enough people who understood the market historically. But we have fixed that and I would like to reassure the public that we have done a tremendous amount in the last twelve months to address those concerns. We have reorganised our entire supervisory effort. We have hired a lot of people out of industry and I do believe we're now set up properly for the future.

SOPHIE RAWORTH: How are you going to control the banks in the future then?

HECTOR SANTS: Well we shall again be clear. At the end of the day the prime responsibility for running a bank well sits with its management, its board, its chief executive and chairman. Secondly, of course, regulation is only part of the picture. The regulator needs to work with the central bank, needs to work with government and needs to work with the grain of society, needs to work with the grain of what people are looking for from their financial system.

SOPHIE RAWORTH: So we can expect to see you in the future step in and say to bank absolutely not? You will be, you will be exercising more control over them and you will be taking bigger steps to stop them doing things that you think are not acceptable?

HECTOR SANTS: If you look back over the last twenty years, the regulatory framework for banks, which is different to us carrying through those actions, is primarily a global framework. It was set up through various global institutions.

I think that framework absolutely needs to be changed and it needs to be tougher. It needs to be tougher with regard to capital, which is a measure we've already taken over the weekend, and it does need to be tougher with regard to behaviours which can lead to reckless risk taking. It's not for us I think to set the quantum of remuneration to determine how much each individual is paid. That is for boards and people should be paid fairly. But we should try to make sure that the structures in the banks don't encourage reckless risk taking which subsequently has detrimental effect for everybody. And we will be doing that in the future, we are already doing that.

SOPHIE RAWORTH: And bonuses, things like that - all that will be cut back? I mean the banking system changes massively forever?

HECTOR SANTS: Well as I've just said, I think it's not for us to be a pay regulator. That is for others to determine, government to determine. But it is for us to try to make sure that the risk mechanisms of pay process doesn't encourage unreasonable behaviour and that we will be doing. So in that sense the landscape will change. But we need to remember of course that the City is a key driver of economic growth in the UK. It is an international centre and whatever we do must be done on a global stage.

SOPHIE RAWORTH: I know bonuses are only one part of the framework for the future, but I mean Gordon Brown has said that the end of the days of big bonuses are over. If you can't really exercise control over that, who's going to be doing it?

HECTOR SANTS: Well I think the matter of quantum is for government. What we can look at is mechanisms as a regulator. We do not have the powers to set quantum, but we should look at the mechanisms and will look at the mechanisms.

BRIAN PITMAN: I don't think a lot of this is possible, quite frankly. A lot of it's totally unrealistic to believe that you can cap pay. If you cap pay in the UK, where are the brains going to go? Where's the enterprise going to come from? We've got to get back to a situation where the markets drive these things again because the markets have been good for the communities in the world. It's the markets, it's the improvement in global trade which Peter Mandelson will know an awful lot about.

It's the global trade which has created the wealth all over the world. Economies are much better off than they were twenty years ago. As I said earlier, in the 70s we had a desperate time. We're not in that sort of desperate time. We've got to free up the markets rather than close down the markets. If you have too heavy-handed regulation, you will kill enterprise - kill it.

HECTOR SANTS: I think that is a key risk. I mean we have seen a number of proposals, particularly I think coming out of Europe, which if implemented could be potentially structurally damaging and we would definitely regret those implementations.

SOPHIE RAWORTH: So this is still a very grey area, isn't it? Just let me just ask you one more question because you have obviously been in banking for 49 years; you still are in it. You have been through probably more downturns than anyone else here. How bad do you think it is going to get? Are we talking about the 1990s, the 1980s, the 1970s, or are we even talking Depression?

BRIAN PITMAN: I think it's different because this is global and the scale is much greater, but I have very great confidence that we shall come out of this. You talk about recession. That's a technical definition. I think we shall be in...

SOPHIE RAWORTH: Are we in one now?

BRIAN PITMAN: I think we shall be in recession. If you want to define that as a contraction of the economy, yes we shall. But the markets will revive. There's no doubt about that. Markets will revive. All the government can do is to mitigate some of these things.

SOPHIE RAWORTH: And is this as bad as the 70s or not?

BRIAN PITMAN: Oh no, I don't think it's anything like as bad as the 70s. We're not going to go onto three day working weeks and we're not... We haven't got that massive inflation that we had in the 70s. I think we've all learnt a lot. But what we mustn't think is that regulation can clear all these problems.

SOPHIE RAWORTH: Okay and can I...

BRIAN PITMAN: I have watched regulation. Back in the 70s we had a thing called competition and credit control, which wound up a lot of competition and not much control. The politicians said we're never going to have that again. Ten years later, we had it again. Then we had the Latin American crisis. So you see animal spirits determine this. What human beings do determines, not governments.

SOPHIE RAWORTH: Sir Brian Pitman, Hector Sants, thank you very much.


Please note "The Andrew Marr Show" must be credited if any part of this transcript is used.

NB: This transcript was typed from a recording and not copied from an original script.

Because of the possibility of mis-hearing and the difficulty, in some cases, of identifying individual speakers, the BBC cannot vouch for its accuracy

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