ECC 4th Report: Annual Accounts of Banks

HL Deb 08 February 1982 vol 427 cc33-78

4.39 p.m.

Lord Plowdenrose to move, That this House takes note of the Report of the European Communities Committee on Annual Accounts of Banks (4th Report, 1981–82, H.L. 42).

The noble Lord said: My Lords, perhaps it would be useful if I could first say something about the draft directive with which our report deals. The origins of the draft directive on the annual accounts of banks and other financial institutions lie in an earlier directive, the fourth company law directive: that is one of a series of directives aimed at harmonising company law throughout the Community. Its purpose was to provide a common lay-out for balance sheets and profit and loss accounts and to set out the rules for the way in which the various items in them are to be valued. It was adopted by the Council of Ministers in 1977 and is being implemented in the United Kingdom by the Companies Act 1981, although the relevant part of that Act has not yet been brought into force. Its effect in this country will be to introduce a greater degree of standardisation into company accounts. It will mean more disclosure in some respects, but it will not bring any fundamental change.

The need for a directive on the annual accounts of banks arises from the fact that there is a gap in the coverage of the fourth directive. Member states have been allowed to exempt banks and other financial institutions from its requirements. This gap was left because of the obvious difficulty of forcing the accounts of financial institutions into the same mould as those of industrial companies. In taking advantage of this exemption, the Companies Act 1981 does not apply the new fourth directive accounting rules to institutions coming under the Banking Act—that is, recognised banks and licensed deposit-takers or, for that matter, insurance companies—all of which, for the time being, continue to prepare their accounts as before. The present draft directive is designed to fill the gap, so far as banks and similar institutions a r e concerned, and in due course there undoubtedly will be a draft directive dealing with the accounts of insurance companies.

The fourth directive and the present draft directive deal only with the accounts of single companies or single banks. They are not concerned with the consolidated accounts of groups of companies, parent and subsidiaries, for which separate directives will be needed. The draft seventh directive, on the consolidated accounts of companies generally, has now reached an advanced stage in Brussels and a draft directive dealing specifically with the group accounts of banks has not yet appeared.

From what I have said so far, noble Lords could be forgiven for supposing that we are concerned with a purely technical measure, dealing with obscure and arcane matters of interest to few outside the ranks of the accountancy profession. But, in fact, this is not so. In drawing up the draft directive, the Commission has departed in several respects from the policy adopted in the fourth directive. One of these—undisclosed reserves—has been the subject of lively controversy, and it is in the confident expectation that many noble Lords with expertise in banking and financial matters will be able to throw light on this question that I am taking up the time of the House.

I propose to outline the main respects in which the draft directive's approach departs from that of the fourth directive, and to indicate the view which the Committee took in each case. I shall deal with the first three briefly and save up the most difficult till the end. Whereas the fourth directive was concerned solely with limited companies, the draft directive would apply not just to banks which are limited companies, but also to banks with other forms of organisation. Banking is an industry in which mutual and co-operative societies of various kinds are flourishing, and in this country the building societies and the Trustee Savings Banks both represent an important segment of the market.

The article of the draft directive which sets out its proposed scope is expressed in terms of the utmost obscurity, and it is not at all certain which institutions would be covered. But it is likely that building societies and Trustee Savings Banks would be covered and the committee, in considering this, thought it to be wise. There is much to be said for having a common accounting framework for all the main types of institutions which take deposits from the public. The committee also had to consider other equally obscure provisions in the draft directive, which would extend its scope to certain bodies which did not take deposits from the public. This was a point on which conflicting evidence was taken and was given. I shall not go into the details, but will simply say that, on balance, the committee felt that it would be altogether much tidier if only deposit-takers were covered.

The second notable departure from the fourth directive is the absence of any exemptions for smaller institutions. The committee agreed with the Commission that bodies which take deposits from the public should be prepared to provide full information, however small they are. The third difference, to which I wish to direct your Lordships' attention, is the greater degree of rigidity which characterises the proposed layout of a bank's financial status. In the fourth directive, these companies have a degree of choice as to how they present the detailed information in their accounts. But the draft directive would place banks in a much tighter strait-jacket, by removing much of the flexibility that was built into the fourth directive.

The Commission seems to have taken the view that one bank is much like another and that there is, therefore, no need for flexibility. This seemed to the committee to be a mistake. The discount houses are an example of a class of bank that is quite different from other banks. Quite apart from the diversity among banks themselves, there is a great diversity in the way that different money markets function; not just the domestic money markets of the various member states, but also the Euro-currency market and the markets in third countries. In the view of the committee, this makes it impossible to lay down standardised definitions and to prescribe categories of balance sheet items without producing misleading results.

The most important respect in which the draft parts company from the fourth directive is in its failure to uphold the principle of true and fair viewing, which noble Lords will recall is the cornerstone of the fourth directive. Since the draft contains a provision which would allow banks to create secret reserves, and to disguise their true profits by making secret transfers to and from those secret reserves, it must be obvious that accounts produced under the draft directive's rules could not be regarded as true and fair within that definition.

In deciding to go down this path, the Commission were no doubt fortified by the knowledge that banks are, in fact, allowed to have undisclosed reserves of one form or another in nearly all countries of the Community, including, of course, the United Kingdom—the cradle of the true and fair view. Nevertheless, it seems to the committee that this was a matter which needed to be looked at afresh, especially since it has been the subject of controversy or discussion—at least, in this country, for a number of years. There is something decidedly odd about a bank directive which aims to harmonise bank accounting throughout the Community, presumably in order to help people to compare one bank with another, but which denies to users of accounts the very information that they most need to know in order to do this.

It was because the true and fair view seemed to us to be desirable, at the very least, in its own right and especially in the context of comparing one set of accounts with another that the committee adopted as its starting point the proposition that it was for the advocates of undisclosed reserves to make out the case for them. The burden of proof, we felt, rested on the draft directive's defenders, not on its critics. I believe that the noble Lord, Lord Benson, will later in this debate say something about the history of undisclosed reserves in this country. The banks, still making use of their exemptions to use undisclosed reserves, comprise chiefly the accepting houses and the discount houses. Both groups want to retain their exemptions. The committee examined with care their arguments for doing so.

There are three main lines of argument in favour of allowing undisclosed reserves. The first is that the profits of banks, especially of small banks and specialised banks, can—and do—fluctuate erratically from year to year. The profits of any one year can be heavily influenced by the arbitrary incidence of the accounting date in relation to the timing of external events such as a rise in interest rates in the case of a discount house. As a result, it is said that fully disclosed profits could be misleading. But this is equally true of other businesses, besides banks. Moreover, it is always open to a company to provide further information to explain fluctuations in profits and otherwise to assist people in interpreting the figures.

The second line of argument rests on the view that disclosure of true results can jeopardise the confidence of depositors—not just depositors in the bank which discloses but possibly in others, too. The Jenkins Committee described this risk as remote. The committee were told that in present day financial markets it is very remote indeed. Not only are markets better informed and less likely to be seized by panic at the appearance of bad news but it is very doubtful whether in a real crisis the ability to conceal the truth can be effective in allaying anxieties. Surely the best way of stopping damaging rumours is often to be open and to give the facts.

The third line of argument is concerned with competitive equality between different types of bank. It can be argued that full disclosure might make it harder for accepting houses to attract business and that this would place them at an unfair disadvantage when competing with banks elsewhere in the world that still maintain undisclosed reserves. On the other hand, not only the clearing banks but also the American banks, who are the leading force in the international banking markets, disclose fully. It has been suggested that full disclosure would place small banks at an unfair disadvantage relative to large ones. This does deserve consideration, but smallness and flexibility is often a great advantage in dealing with massive and often slow-moving institutions. But in view of the many weighty objections to undisclosed reserves, smallness seems a doubtful reason for allowing them to remain. In short, the committee were not convinced by the arguments in favour of undisclosed reserves and came to the conclusion that they should not be permitted.

I look forward to listening to your Lordships' views on this, in particular those of the noble Earl, Lord Airlie, and the noble Viscount, Lord Chandos, who are both making their maiden speeches and who occupy such prominent positions in different parts of the City of London. I beg to move.

Moved, That this House takes note of the Report of the European Communities Committee on Annual Accounts of Banks (4th Report, 1981–1982, H.L. 42)—(Lord Plowden.)

4.55 p.m.

Lord Lever of Manchester

My Lords, I am sure that we are all deeply grateful to the noble Lord, Lord Plowden, and his committee for the careful consideration they have given to the problems which will arise in considering the new proposed directive.

May I begin on a rather abrasive note? I cannot help lamenting that the Commission so often gives pleasure to its antagonists when directing its mind, or that of its highly erudite and intelligent agencies, to very important areas by focusing on the marginal problems of that area rather than on its fundamental problems. It seems to me rather odd at the present time, when we ought all to be very much more concerned and more knowledgeable than we have been in the past about the structure, management and approach of our great banks, that we are now focusing the attention of the Commission, and in our own case the attention of one of the weightiest and most knowledgeable committees that the House enjoys, on the question of the undisclosed reserve problem, which has been with us for some time. I will give the House my views on that question, but it is right that I should utter a word of anxiety that, to use a phrase for which I cannot claim copyright as it is not possible to copyright it, people with great responsibilities, when faced with hard problems, have the unfortunate and damaging reflex, instead of focusing on the centre of those problems, of tending to frolic on the margin. I must say that for so much brain power, wisdom and experience to be focused on the margin of the European banking problem, as it has been in this committee, seems to me to be a great waste.

I should have liked our select committee to have had the opportunity, for example, to consider the way in which banks lend money to sovereign states, which may be of considerably more importance to their solvency and their ability to meet their liquidity. I am not criticising the committee, I hasten to say, because that was not their mandate, but I should very much like the Commission, and hence our own appropriate bodies, to consider some of the dangerous situations which arise from the vast lendings—unstructured, unsupervised, uncontrolled and largely unknown as to extent—that are going on at the present time from our great banks in an outflow of their funds in all sorts of directions from Poland to Chile, Brazil, Zambia, Zaire and the like. These matters, which are far more relevant to the necessity for maintaining a European banking structure of solid reliability, ought to have priority over the issues that we are discussing today. Important though the latter are from an administrative point of view, they are not of any great urgency. It seems to me that we must not allow the commission to get into the habit of putting last things first and ignoring first things altogether in matters of this gravity.

Turning to the report, at first sight it must be very easy to obtain unanimous assent for the idea that every company in every circumstance should present a true and fair report of its trading and activities. I think nobody would cavil at that proposition as a general one. When we come to real life, we find that in practice it is not always possible to achieve this desirable objective, or to place a formal legal obligation on companies to achieve it in a meaningful way. For example, I think we should have to have detailed disclosure of all property assets of all companies, and a fairly continuous revaluation of them, if we are to decide on how much capital is being employed in the company, and I think it is absolutely right that stocks, for example, of a trading company, or a finance company which has its own stocks, should be stated on the basis of cost or market price, whichever is less. But when it comes to assessing the market price there is no means by way of statute that can produce a result which guarantees either to a potential creditor or to a shareholder that he is adequately informed as to what has happened to the company.

Take the case of a company which is rather different from, say, a discount house. A discount house's stock is gilt-edged stock and bills it has discounted and advances it has made. There it would not be easy for them—especially, for example, in the case of gilt-edged holdings—not to disclose exactly what the market price was. It is not a matter of taking a kindly view of the market price; it is there in the daily papers every day, very precisely. But, if it is a leather company or a textile company, it may have millions of pounds of stock at cost, may be much of it left over from years gone by; it is in the happy position that it can, if it wishes, take an optimistic, or an over-optimistic, view of the likely realisation. I am not suggesting that directors, if they have a balance against them, take an over-optimistic view; they have a duty and a reputation for integrity which they have to preserve. The same goes for debts, incidentally. A judgment on the value of debts and what provision has to be made for debts is always, again, subject to optimism—deliberate optimism sometimes, and deliberate pessimism sometimes, though deliberate pessimism, to be effective fiscally, requires the rather difficult task of persuading the Inland Revenue to share that deliberate pessimism, and they want a certain caution, but it does not stop a company from achieving this. So let us not start this with an artificially naïve assumption that every company actually can or does succeed in achieving the absolutely sensible, honourable, desirable objective of a true and fair view of the accounts.

Against that background, I look at the question of the argument for banks achieving undisclosed reserves. For quite a long time—here the noble Lord, Lord Benson, will probably assist—the great banks in this country used to join with the small banks in asserting that their depositors would have a fit of great nervousness if they were to learn the true accounts, day to day, year to year, unadjusted by the movement of concealed reserves. Eventually, the laughable nature of that argument, I assume, made the great banks voluntarily offer to abandon secret reserves. Nobody can suppose that Barclays or Nat West, or any of our great banks, are in a tremor of trepidation every annual account about their deposits being moved if their accounts show truly what the profits are. Although, again, I must make the reservation that truth is not an easy objective to achieve in these matters, in the sense that there are various versions of the truth that can be properly held by honourable men facing very complex accounts which have to be valued. Still, the great banks seem to have survived, without undue injury to their depositors' confidence, the abandonment of secret reserves. Why do the smaller banks require it? I can see that it is embarrassing to a bank, or to anybody, to show that he has had a bad loss during the year. I can see that, in the case of quoted companies, it could call upon the heads of directors a certain amount of critical comment about how they perform, and, very often, unfair comment. Nevertheless, I think that, in order to claim that you should have an undisclosed body of cash to modify the results, you need a very substantial argument for doing so. The only argument that I know of is that depositors would be alarmed if they saw the true position.

It raises two questions. First, anxiety is proper in certain circumstances and eliminating it by adjusting your profits out of concealed reserves may be unfair to a man who ought to feel anxious. I really do not know that as an abstract principle the case has been made in any way for making this provision for secret reserves in the case of bankers on the ground that depositors would be worried. It may be that they ought to be worried in certain circumstances. It may be that they will learn that fluctuations in banking profits, especially in discount houses and acceptance houses, is a normal matter. I know that noble Lords who are very knowledgeable about discount houses and acceptance houses will tell me of all the agonies of revealing year by year what has happened. I can see that it is much more agreeable for them not to have to reveal it. But I cannot see, and I have not heard, the case which makes me see the justification for discount houses and acceptance houses enjoying the privilege of distorting—I am not using this word offensively; adjusting, if you like—favourably, one year's profits by using, unknown to the shareholders, unknown to the creditors, unknown to the public, profits which have been put by secretly in years gone by.

And I can see, quite apart from the general merits, some very serious objections to this. First, shareholders are entitled to look at the balance sheet in order to assess the performance by the directors in the handling of their assets. Let us take the recent period. The gilt edged market has recently moved into a kind of frenetic condition which was never known before. It is very proper that shareholders should wish to know, or potential investors in the company should wish to know, whether their management has adapted shrewdly, wisely, cautiously, or, if you like, adventurously, to the new frenetic conditions of the gilt edged market. If the company had huge secret reserves, the company could have reacted in the most reckless, foolish, ill-considered way, and could appear to have improved their performance, compared with their rivals, who have apparently performed worse, but in reality, better. I cannot see that that can be a desirable state of affairs.

There is something else that troubles me. Directors, in my opinion, ought to be welcomed as shareholders in their companies. There is nothing more in accord with the enterprising spirit than that a man puts his money where his work is—in the case of banks, in his own bank—to some extent, and he must judge the extent. It seems to me that if you have provision for undisclosed reserves you are going to place directors of smaller banking companies quoted on the stock exchange in a very ambiguous position of difficulty in investing in their own company or divesting the shares in the company. When he goes to buy the shares, however much subject to regulations about directors buying shares and disclosing shares, he is buying with greater knowledge than the man in the street has, or than the man selling the shares has. I may hold discount market shares and I may be bid a larger price than usual, and I may part with the shares, not realising that it is a director of the company who has bought them, and, of course, not realising what is the amount of the secret reserves and assets in the company, which again may very much affect the judgment of a share-holder in parting with shares or buying shares. Secret reserves, by adjusting the profits within a very wide range according to the size of the reserves, may give the impression that the company is performing well when it is performing badly. Secret reserves may equally give the impression—I see that the noble Lord says that I am wrong; if he cares to correct me I shall gladly give him the opportunity of doing so—that the company is doing well, relatively speaking, when it is doing badly. Secret reserves may give the impression that the company is doing nothing particularly well when in reality it may be enjoying a bonanza. For all those reasons—

The Earl of Limerick

My Lords, I wonder whether the noble Lord would be kind enough to allow me to comment on that point because it is rather fundamental? There are strong accounting conventions which are enforced by the auditing profession which would prevent the thing which the noble Lord, Lord Lever of Manchester, has premised—that is, that the disclosed results of one of the banks which is subject to the Schedule 8 exemptions would not run counter to the trend of profits. In a year in which they had actually done worse they would never disclose a higher result or vice versa. This would have the effect of smoothing, but not of reversing the trend.

Lord Lever of Manchester

My Lords, I am sorry if I did not make myself plain in detail. In a year in which banking profits have gone up by the discount market—normally by, say, 15 or 20 per cent.—if I am a discount house and have large secret reserves there is nothing whatever to show, by taking a lesser amount than I have done in previous years to the secret reserves, that this year I have made 30 per cent. Nobody could complain. I have made 30 per cent. The only difference is that I have not added my usual substantial wad to secret reserves, but a very much lesser sum. So the impression that those figures will give will be that I have made an outstanding profit in the discount market. In reality, because I have denied myself the usual £3 million to secret reserves and only placed £¼ million—no accountant or auditor would object to it if I reduced that amount because my secret reserves are ample by this time—I give the impression of having out-performed everybody on the discount market. When I made the point I think I did add, "relative to other people". When you have done badly relative to other people, when you are making only a 5 per cent. increase in your profits whereas the generality are making 20 per cent., you could shows yourself well in the van by simply reducing the amount from your secret reserves or contributing something from your secret reserves.

Having said all that, I still am in very grave doubt as to whether this is a proper matter for the European Commission to legislate on and I take that view for the following reason. The great objection I have is that directors have an embarrassment in dealing in their company shares because they have a higher stake of information than the market, than the man in the street. Nevertheless, the shareholders of the company can themselves, to some extent, modify this. It is not a great and urgent matter. But I, therefore, wish to raise a doubt as to whether the long-established practices of the City in this area should be overridden by the Commission. I am quite sure that if they are to be overridden then they have to be overridden by a different directive from the one proposed. The proposed directive proposes to allow secret reserves but in a manner more usually present on the Continent than in this country and different from the one which by long tradition has been maintained here and without, so far as I know, the monitoring supervision of the Bank of England which takes place here.

So, although I see no case in principle for secret reserves, if the House were debating whether we ought, as a matter of national legislation, to modify or remove secret reserve provision for the discount houses, as at present minded I would vote for the abolition of this right to secret reserves and the right to adjust profits by the use of the secret reserves. However, we are not giving that examination. We are not likely here to go into the detail into which we would go with national legislation. I know of no reason for harmonising this matter at present and I know of no reason why, if there are to be these provisions, they should be harmonious throughout the Community in regard to reserves. I must confess that If would any day prefer the existing secret reserves, which I do not support, but monitored by the Bank of England—and it is a very restricted number of companies who are entitled to keep them—to the general provision proposed which allows people to create a secret reserve in the manner suggested in the draft directive.

I should like to make one or two small points in addition. I am not sure that the proposed directive is wrong in demanding the accounts of branch banks. I think that there is a difference between asking Barclays to produce a branch account for its local branch in Manchester or Liverpool and asking a foreign bank to come to a foreign land to produce branch accounts. I must say that I am not necessarily persuaded that that should be abandoned in favour of forcing the bank to reveal a balance sheet—which they have to reveal anyway, I would hope, before they are allowed to trade continuously to the public—perhaps stated in currencies which are not understood and the assets of which are not checkable in Europe itself.

As to the other matters recommended by the Committee, I have no hesitation in giving them my full support and I must say that I would agree with their judgment if we were discussing an Act of Parliament that the whole case for secret reserves on discount houses and accepting houses should be reviewed. I do not think that this is a matter which should be changed in the way proposed and I am not at all sure that it is necessary to change it by Community legislation.

5.18 p.m.

The Earl of Airlie

My Lords, I have to confess to having some sense of guilt because this is the first occasion on which I have spoken in your Lordships' House. As some of your Lordships will know, I have had the option to do so for a little time now. I am not sure, therefore, whether I have the right to ask for your Lordships' indulgence, but, nevertheless, I would like if I may to do so.

I am anxious to participate in this debate on the Select Committee's report on bank disclosure, and I would like to speak in my capacity as chairman of one of the accepting houses in the City of London. I would like to confine my remarks to the effects that the recommendations of the Select Committee would have on that body. I am very conscious that the Members of the Select Committee are very distinguished Members of your Lordships' House. I fully appreciate that they have a very great knowledge and experience on the subject which they have been studying. It is, therefore, with some degree of hesitancy that I would like to take issue with them.

But I am bound to say that I am not a little concerned about their recommendation that accepting houses should not be permitted to maintain undisclosed reserves. I do not think that sufficient attention, or perhaps weight, has been given to the special circumstances of accepting houses and the need to be prepared to deal with them or to treat with them differently, because I believe that they are different from the clearing banks.

The differences are quite material. Merchant banks, as they are very often known, are basically wholesale banking businesses. They are not large retail banks with many branches throughout the world. As such, they have a very much smaller capital base and, as a result of this, deposits, of course, are not so widely spread. Likewise, the loans that they make are primarily made to corporate bodies and they tend to lend, in quite large figures, related to their capital base. So the loan-loss provisions can have greater impact than is the case with the clearers.

Of course, over and above that there is the whole field of investment banking—to use American terminology—which is a very important part of an accepting house's business. It covers a whole range of activities which include underwriting of both domestic and foreign securities and, of course, portfolio investments. The point I am trying to emphasise is that the nature of a merchant bank's business is such that it is less predictable—if I can put it that way—than that of a clearing bank.

As a result, independent merchant banks have to manage—and I think do manage—and conduct their business as prudently as possible. As part of that posture I, for my part, think that it is just sensible, prudent and wise to be allowed to smooth the peaks and the troughs in profits when it is thought appropriate. The case for prudential reserves has been made by the Accepting Houses' Committee in a memorandum which it submitted to your Lordships' Select Committee. Here and now I should like to say that, of course, I support the contents of that memorandum and its recommendations.

However, perhaps I could demonstrate my concern by asking your Lordships for one moment to assume that the Select Committee's recommendation has become effective. Let us also assume for one moment that some economic or financial crisis has developed. Let us make that assumption. In those circumstances an accepting house would, of course, be faced with making certain provisions, and these would have to be made at their year end, which, of course, I would emphasise is an entirely arbitrary date. In most instances these provisions would be purely subjective decisions—they would be purely a matter of judgment. They would, of course, include the need to provide for bad debts, but, under this proposal, these would no longer be allowed to be averaged over five years, which is an important point.

There could also, of course, be certain provisions which are required to be made in respect of their investment portfolios or any outstanding underwriting positions. The decline in profits in that year would, of course, in this example be fully disclosed. But it may very well be that in the following year the economic and financial tide has totally changed, and we shall then find that there is a need for writebacks, and a great increase in profits would then be shown in that year. I would suggest to your Lordships that it would be much better to have been in a position to smooth the accounts over that period, thereby, in my personal opinion, presenting what I would regard as a truer and fairer picture of the bank's position and condition.

In fact, I shall be surprised if the continental banks will readily agree to the Select Committee's recommendations. However, I should very much hope that, if foreign banks are allowed to continue to maintain prudential reserves, no unilateral decision would be made by the United Kingdom.

Lord Lever of Manchester

My Lords, it is not prudential.

Noble Lords

Order, order!

The Earl of Airlie

My Lords, I think that this really would put the accepting houses at a competitive disadvantage with foreign banks. I am fully aware that intellectually a case can, of course, be made for full disclosure and I understand the arguments and appreciate them. Indeed, they have been very ably made by accountants, journalists and stockbrokers who gave evidence to the Select Committee. But my belief is that you would expect that from them. That has to be their professional approach.

But I want to emphasise that we are dealing with sensitive and entrepreneurial institutions which, I think it is fair to say, have been in the forefront of the development of the City of London as a major international financial centre. I believe that if they are no longer permitted to maintain prudential reserves, not only will they be put at a competitive disadvantage with the bigger banks, but in my judgment will become, somehow or other, just less enterprising, that much less aggressive and, therefore, less successful in the market place.

I think that they could probably be less willing to risk supporting industry, particularly in the areas where the Government are so anxious to gain support. I do not think that this is the outcome which your Lordships seek. I ask whether it is worth running these risks. I, personally, do not believe so. So I should like to recommend, the adoption by the Commission of our existing practice—which has been well tried—of presenting our accounts. But on the basis that a non-United Kingdom system is to be adopted, I would recommend that Article 37 of the directive be retained, but that it would have to be amended as proposed by the accepting houses in their submission to your Lordships' Select Committee.

5.28 p.m.

Lord Benson

My Lords, I should like to congratulate the noble Earl, Lord Airlie, on his maiden speech. I do not often disagree with him, either in the City or in other spheres, and I have some reservations about what he has said to this House today, but the clarity, lucidity and, indeed, the gentleness with which he has expressed his views commend them to everybody in this House.

I should like to support the noble Lord, Lord Plowden, in moving the reception of this report. I believe that the whole substance of it rests on this one single point of secret reserves, and I shall address my remarks only to that point. In 1948 a new era occurred in the history of financial administration in the United Kingdom when the Companies Act 1948 was passed. That required all companies—but banks were exempted—to show their true profits and losses, and did away with the practice, which previously existed, of having secret reserves. The words "true" and "fair" were invented; they were enshrined in the Act, and they have been used in every auditors' report since that time.

In 1978 the fourth directive was issued. That applied to all companies, excluding banks, but in that fourth directive the words "the principle of true and fair" were enshrined, and a great deal of credit rests on the accountancy profession in this country, and a great many others who have helped them, who were able to persuade our colleagues in Europe to follow that principle.

The position as regards banks is different. In 1948, when the Companies Act was passed, it was then the view, now generally believed to be mistaken, that it was necessary for the creditworthiness and the stability of banks that they should be allowed to maintain secret reserves. Since 1948 thought and sentiment have changed. It is now generally the view—and I shall explain why in a minute—that all banks should be required in future to show their true profits and losses and not to conceal them by transfers through secret reserves.

The reason why I say that this view is generally held is this: it is the view of the accountancy profession worldwide. In this country it is the considered view of the clearing banks. It would be welcomed by the stock exchange. The financial analysts who speak on behalf of shareholders and investors strongly support that this exemption should no longer exist. Your Lordships might therefore feel that the report is pushing at an open door, but this is not so. There is a pocket of resistance and, as has been pointed out, the 16 accepting houses and the 12 discount houses in the country have made representations that the exemption should continue.

Your Lordships' committee, which includes in its number many eminent bankers and industrialists, did not feel that there was much merit in their proposal. Indeed, their case has been gravely weakened because it is common knowledge that they are divided among themselves and are by no means unanimous on this issue. What is important is that we should isolate the precise reason why this exemption is claimed.

In the past numerous reasons have been given: special risks; competition, national and international; type of business; size; the interest rate cycle, and the economic cycle. My Lords, those shibboleths have now been discarded, and have rightly been discarded, because they apply to every business in the Kingdom and they apply to a great many businesses with much greater severity than they apply to banking institutions.

The sole reason why the exemption is claimed—and I shall give your Lordships the references in a minute—is to preserve the confidence of depositors. That is the sole argument that is now advanced. Lest there be any doubt on that issue, I draw your Lordships' attention to paragraph 42 on page 28 of the report. This was the evidence given by the British Bankers' Association, the evidence of the leader of that association, who himself comes from an accepting house. He was speaking about the confidence of depositors. He said: My own view is that that is the only basis for this case for hidden reserves ". Then, in case there was any doubt as to what he meant, he repeated it, and said at the end: we are asking for the privilege as bankers who take deposits from the public and for no other reason ". He made the same remarks on a previous page in paragraph 39. No evidence, written or oral, was put before the committee to justify the assertion that you lose the confidence of depositors if you tell them the truth. On the contrary, there is an abundance of evidence, to which I shall draw the House's attention, showing that if you do tell the depositors the truth you retain their confidence.

I shall revert for one moment to talking about the "smoothing" of profits. This is an anodyne phrase which is spattered all over the evidence, and I am sure we shall hear it from time to time in this House this evening. What should be appreciated is that the smoothing of profits is only a euphemism for the concealment of losses or of inadequate profits. There is nothing wrong with making losses. Anybody who engages in business knows that you cannot make profits without being prepared to make losses, but what is unsatisfactory is concealing them and their amount and how often they take place, so that the quality of management cannot be appraised.

I should like to give you the six reasons—I suggest that they are compelling reasons—why the views of the accepting houses and discount houses should not prevail. The first compelling reason is that anybody who has the care and custody of another person's property should account for it frankly and openly. Particularly losses should never be concealed. This is the first principle of accountability. I hope that neither the Government nor this House will ever be deflected from holding that principle as inviolate.

The second compelling reason is that shareholders, creditors, depositors, investors, staff and employees, each for their own separate reasons, are entitled to know the strength and weaknesses of any banking business in which they are interested. Common sense dictates that this information should be available to them. They cannot make a balanced judgment if the truth is concealed from them.

The third compelling reason is the experience of the clearing banks themselves. They had the right, as other speakers have pointed out, to this exemption under the 1948 Act. They abandoned it no less than 13 years ago. It was not necessary, and they did not need it. They have thousands upon thousands of depositors and hundreds of millions of pounds at stake, but there has been no loss of confidence by depositors by reason of telling them the truth. Time is against me, else I would read to your Lordships the considered view of the clearing banks, but may I just direct your Lordships' attention to it in case you want to look it up; it is in paragraph 63 on page 31 in the left-hand column, which puts the position of the clearing banks with remarkable and straightforward clarity.

The fourth compelling reason is this: that if an acceptance house or a discount house, or indeed any other undertaking, wishes to obtain a listing on the stock exchange, it is required by law to declare its true profits and losses and its true assets. That must also be done in subsequent mergers and amalgamations. This situation has happened in numerous occasions in recent years. The true profit and losses of those houses have been disclosed, but there has been no loss of confidence by depositors. It really is absurd to suggest that the true profits and losses are disclosed for one purpose, and immediately thereafter the policy of concealment is followed for fear that the confidence of depositors is impaired.

The fifth compelling reason is this, that credit worthiness, trust, reputation and stability are dependent on telling the truth and not concealing it. If any customer were to go to any banking house and say, "I wish to do business with you. These are my accounts. They do not show the correct position. They conceal my profits and losses. They conceal my assets", he would be sent away with a flea in his ear. That is made abundantly clear in the evidence before the sub-committee. There is no reason why the same standard of financial behaviour should not apply to the banking houses; what is sauce for the goose is sauce for the gander.

The sixth compelling reason is the situation in America and Canada. There are in those territories many hundreds of banks of every sort, size and type, national and international, specialist and otherwise. For long years they have been required to disclose their true profits and losses and their reserves, but there has been no loss of confidence of depositors there. It verges on the ridiculous that that should be the experience in those two great countries, yet at least 28 houses, divided as they are among themselves, should require this exemption which they are now claiming. For all those reasons I suggest that the report of the subcommittee is soundly based and should be followed. We should for a moment look at the position in the other European territories. In Holland and Germany they are entrenched in the view that they should maintain secret reserves. In Luxembourg and France the position is confused and obscure, but I suspect they indulge in the smoothing of profits. Italy claims that all its banks disclose all their profits, but having had some experience of Italian accounting in the past, I have a nagging belief that that claim may not be justified. In Belgium, the Banking Commission urges the banks to make full disclosure, but there is no law of compulsion requiring it. In Ireland, full disclosure takes place in practice. In Denmark, secret reserves are prohibited by law. In the light of that mess and confusion I suggest it is high time that all banks should now be put on a proper basis and should no longer be allowed to conceal their reserves.

It is fitting that I should end on a simple point relating to the attitude in Germany. The Germans are the most entrenched and most vociferous on this issue. They were kind enough to allow three of their members to come and give oral evidence before the committee. I think it is not unfair to say that the answers they gave were not very convincing. However, there is one particular question and answer which really exposes the attitude of mind in Germany to which I draw your Lordships' attention. In paragraph 109 on page 53 a very simple question was put to them. It was never in fact answered, but in the reply that was made this extraordinary statement emerged: This might sound hostile from my side but I think if you give someone information, delicate, difficult to understand, who is not in a position to understand it, to work with it, that is more dangerous than to give him no information ". In other words, he was saying that the depositors are such a bunch of ignorant ninnies that the bankers are entitled to deceive them. Apart from the arrogance of the statement, it displays an attitude of business morals and business ethics which I find totally repugnant.

5.44 p.m.

Viscount Chandos

My Lords, I am grateful to the noble Lord, Lord Plowden, for raising this subject and allowing me to speak on it. If it is appropriate for one novice to congratulate another, I should like to add my congratulations to the noble Earl, Lord Airlie, for an exceptional maiden speech.

The noble Lord, Lord Plowden, and others whom follow and who will follow me have far greater experience not only of speaking in your Lordships' House but also of the world of banking and industry. I should none the less declare an interest as a banker. However, in surveying the collective financial experience of your Lordships here today, I feel that I should not present my views as those of a banker but more as those of a layman who has begun to disentangle a few of the mysteries of banking.

As noble Lords who have spoken before me have covered the principal arguments highlighted by the report of your Lordships' committee, I feel that I should make my contribution as brief as possible. The European Community set out in its draft directive to harmonise the way in which the accounts of banks and other financial institutions are presented throughout the EEC. If that could be achieved without undue problems to the banks, which have previously adopted differing standards, then it seems to me that it is an objective worth striving for. There will, however, inevitably be some costs in introducing harmonised standards and I believe this debate offers an opportunity for your Lordships to assess whether those costs are justifiable.

The area which inevitably attracts most controversy relates to the right which banks in most Community countries, as the noble Lord, Lord Benson, explained, and certain banks within the United Kingdom, have to conceal their true profits. As Lord Benson said, the whole question hinges on the matter of confidence, which is essential to the functioning of any banking system. However, the role of the Central Bank as lender of last resort and guardian angel for the national banking system has now become arguably a more important factor for maintaining confidence than the existence of undisclosed reserves.

Banks and financial institutions that were not bastions of the British financial market have been supported in the past by the Bank of England and in many cases the scale of losses has been such that undisclosed reserves may well have been irrelevant. If it could be argued that the maintenance of undisclosed reserves by British banks lessened the level of monitoring and the degree of potential support which the Bank of England had to give, then perhaps the principle of hidden reserves would not have to be seen as a luxury.

The noble Lord, Lord Benson, and other noble Lords who have served the Bank of England are far better qualified to assess that question than I am. I believe, however, the potential costs in terms of the efficient working of the banking system may be too high and I shall explain why in a moment, but first I should like to comment on one piece of evidence given to your Lordships' committee. It was suggested to the committee that the inherent volatility of the financial markets and the banks' exposure to that volatility was far greater than anything that inflicted industrial companies.

Recently one of the major discount houses, Smith St. Aubyn, revealed losses which it stated had eliminated its disclosed and undisclosed reserves. Last year one of the country's major high technology companies, ICL, having two years previously appeared to be flourishing, saw all its existing capital eliminated in a single year through the combination of trading losses and exceptional write-offs. Even since Smith St. Aubyn reported its losses, an improvement in the gilt edged market has restored some proportion of the capital which it had previously lost. The efforts of the new management at ICL to combat the formidable competition in its industry and the adverse economic climate worldwide will take longer than one month to bear fruit.

Therefore it seems to me to be unjustified to argue that banks face a uniquely hostile environment in which to make consistent profits, since changes in demand and technological developments are formidable problems for a manufacturing company to face, in addition to the influence that changing financial markets can have on them as well.

The interlinking of banks and other financial institutions may of course be greater than that which applies to other industrial companies, but it certainly should not be thought that the loss of confidence is relevant only to the business of banks. The recent unhappy collapse of Laker Airways undoubtedly owed something to the loss of confidence among customers and travel agents in Laker's ability to weather its current financial problems.

Therefore I feel that the case for banks being granted privileged treatment compared with other limited companies is not proven, and I need to be convinced that their ability to build up undisclosed reserves is a substantial contribution to the maintenance of confidence in the banking system.

I should also like to make one other comment concerning the possible effect of concealing the true profitability of banks. As the noble Lord, Lord Benson, said, the interest of shareholders should certainly be borne in mind, and I believe for one particular reason. Just as a bank's business is dependent on its ability to attract deposits, so its expansion of business is dependent on the growth of its own capital. At times banks need to raise new capital from existing shareholders and other investors, and the terms on which they can do so arc often dictated by those investors' views of the banks' profitability and prospects. Sadly do not expect that the revealing of the true profitability of banks would transform investors' views of the banks. Indeed, many banks which reveal their true profits suffer as poor a rating in the stock market as those which do not.

None the less, the importance of bank's role in the economy, both in lending to domestic industry and in recycling international liquidity, makes their capitalisation of more than academic interest to almost everybody. In my view, any trend away from full disclosure is in the long run more likely to inhibit the proper valuation of banks and reduce their potential growth of business. I believe therefore that the European Community's proposals represent a retrograde step and an unjustified cost in terms of the efficiency of both British banking and the banking system throughout the Community.

5.53 p.m.

Lord Seebohm

My Lords, first, I should like to congratulate the noble Viscount, Lord Chandos, on his splendid speech. In fact I should like to congratulate both the maiden speakers whom we have heard this evening. They did not exactly seem to agree with one another, but I think that it will be all to the benefit of the House if we hear them both again in the future, very likely taking opposite views. They will certainly be well worth listening to, and I congratulate them.

I have been told that in the late 'eighties or early 'nineties of the last century my grandfather, who was a senior partner of a small country bank, rather dismayed his banking colleagues by insisting on having an outside audit. I believe that the auditors' certificate ran something like this: We have examined the bearer bonds, the Treasury bills, and the cash, and found them correct ". I gather that someone asked my grandfather whether Mr. Waterhouse, who was the auditor, had looked at the accounts and the loans, to which my grandfather replied, with some indignation, "What, show them the private ledgers?—not on my life!".

That was some time ago, and things have moved some way forward—or have they? I remember, too, when I first joined the board of a clearing bank, which was just after the Cohen Report, in about 1947, many directors of the bank felt that full disclosure was quite unthinkable. In fact in a few years' time—I think it was in 1951—we were rather glad to have quite a lot of reserves which we could use internally. As your Lordships might recollect, that was the year when Dalton's song in his heart died, when his 2½ per cent. Treasury bills without a date fell about 20 points in a matter of weeks, and it was extremely difficult—in terms of 31st December—for the banks to draw up balance sheets. So far as I know, they used up all their inner reserves, and even then were not able to show their gilt-edged investments at the market price in the balance sheets.

Things moved on, and I am glad to say that after some years the banks were able to build up their reserves again. By the time it came to 1969 there was no question in the minds of I think practically all the clearing banks that the days of concealed reserves were over, and it so happened that my bank was the first to appear, not because it was any more original than any other bank, but because it happened to have a year ending in September rather than in December.

The fifth directive that we are discussing this evening is a complicated one, and of course any attempt to harmonise the accounting framework of financial institutions and banks is bound to be exceedingly difficult for the simple reason that not only do they differ among themselves, but they vary from country to country. If we take the discount houses here as an example, I do not think that there is any comparable institution in any other country in Europe. As I say, most of the problems are technical, and probably will be ironed out in various discussions that are bound to take place. But the question which everybody here seems to be interested in—that of hidden reserves—is by far the most important and contentious subject. I shall deal with this matter first. Though everyone else who has spoken so far has dealt with it, I should like to mention certain matters that I do not think have been completely touched upon.

First, I realise that feelings run very high on this matter and that some of the most experienced and leading figures in the City are still very anxious to retain the principle of undisclosed reserves. So I believe that this is a subject that we must handle with great care, and we must think seriously about the various arguments. I should like to repeat what I think are the four most important arguments and say why I cannot really go along with them. The reasons put forward by the acceptance houses are as follows. First, being smaller, they cannot have the same spread as the bigger banks of either lendings or deposits, which means that they would have much wider fluctuations in loss experience; and with that I agree. The result of this situation on the profit and loss account can cause wide fluctuations from year to year, so that the accounts of any one year cannot accurately reveal the real success or failure of the business.

The next reason—I think quite an important one—is that in a different year the fluctuation could cause a loss of confidence by the depositors, with a possibly disastrous effect on liquidity. Tie last reason with which I wish to deal is that the abolition of the undisclosed reserves can only favour the competitive position of the bigger banks, which is not necessarily desirable.

In my view, all those arguments have weight, but what we have to decide is, how much weight? I am not very impressed by the accountants' argument that they cannot certify a report of a company, shelting under the provisions of the 1948 Act, as true and fair. In fact, well before we made full disclosure, the report and accounts of my own company were always audited by four of the major accounting firms in the City of London as true and fair, subject to the qualifications in the 1948 Act. Quite frankly, I think that "true and fair" has become a sort of meaningless phrase. It has been used for too long, and I really do not quite know what it means. For instance, can the accounts be true and unfair, or can they be untrue and fair? What in fact is really meant when an auditor signs the accounts of bank and says that they are true and fair?

The assets of all financial institutions can be valued only on the basis of judgment. I should like to take the example now of Polish debts. For example, one bank may well say, "The situation in Poland is so disastrous that we must make full provision or write them off in this year's accounts". A second bank may quite well say, "No single country behind the Iron Curtain has so far defaulted, so obviously the USSR cannot lose face in this respect. They will stand behind the Polish debts, and, therefore, there is no need to make a reserve". The third bank (which I think might be me) might say, "We really do not know what is going to a happen, but it will probably be prudent to write if off over, say, a five-year period, during which time we will be able to see what is happening, and it would be only fair, perhaps, to load some of the future profits with this slightly doubtful proposition".

The auditors will audit the accounts of all those three banks. Are they true and fair? Are they all true although they have taken entirely different decisions on very large debts? I do not know. Anyway, my point here really is that it is the directors and the directors only of a bank who can decide what is the proper valuation of an asset. The auditors can express a view to the directors if they wish to do so, but I do not think it is necessarily right that they should have to say that the accounts are true and fair. This may be a small point, but it is certainly one of the arguments that some of my friends in the City have raised. This may be an extreme example, but every asset in a bank has to be valued yearly by someone.

I do not think I need go on about that, but certainly in my experience the auditors, with one or two variations of phraseology, have been perfectly happy to certify the accounts of banks with undisclosed reserves for decades, if not since the beginning of the century. That is their case, and now I am going to say why I do not go along with it.

First, it will be remembered that when the clearing banks undressed in public there was general surprise expressed by the media that the inner reserves were so small. I wonder what would happen to a merchant bank if it was found that they were very large. This did not shake the public in the least; nor, in my view, will it shake the customers of the smaller institutions now that the Bank of England has taken much firmer steps of supervision and has shown by the lifeboat exercise that no responsible institution is to be allowed to fail simply because of a lack of deposits.

Secondly, British merchant banks perform quite a different role from that of the clearers, as any large industrial or commercial company will tell you. They will remain just as competitive; in fact, everybody knows that they take more risks, and that is one of the reasons for their high reputation. What the merchant banks will need to do is to be very much more forthcoming in explaining to their shareholders and the public the reasons for increased or decreased profits, and rather more explicit in forecasting. Finally, I really do believe that, by removing a rather comfortable cushion, the spur to efficiency, managerial discipline and competition will be beneficial.

Before leaving the subject altogether, I must refer to the German position, which I believe to be more sensitive for historical reasons which are well known, and also to the present somewhat desperate situation in which many banks in Germany find themselves. This is rather going back to the situation in which the British banks found themselves in 1951. However, one of the reasons why they are in these difficulties, as I think most people realise, is that they have been encouraged since the war, owing to the lack of other financial institutions, to lend money far too generously and gear far too highly the many companies they financed. This is now proving absolutely disastrous in a period of recession, and I think some members of the Wilson Committee might take note of that, and possibly some members of the Government.

My Lords, most of the matters are adequately covered by the Select Committee's recommendations. There are, however, one or two matters that I feel I should mention. First—still on the subject of asset valuation—the value of maturing securities should certainly be valued on the basis of remaining maturities and not on cost. The latter proposal makes no sense at all.

Then, as I think has already been mentioned, there is the question of branch balance sheets. This, again, makes no sense to me. Quite apart from the arguments put forward by the noble Lord, Lord Lever, I believe it is impossible to make them mean anything because reserves are usually made centrally, profits can be made either at head office or in the branch, or wherever you like in the bank, and to get a realistic picture of a branch would be quite impossible.

Finally, I hope, though, that there will be more flexibility in the presentation of accounts when this matter is finally settled, as functions differ so very greatly from country to country and from institution to institution. I strongly support the report.

6.6 p.m.

Lord Roll of Ipsden

My Lords, perhaps I may begin by joining with other speakers in congratulating the two maiden speakers, the noble Earl, Lord Airlie, and the noble Viscount, Lord Chandos. I hope we shall hear them often in this House. I have to declare an interest, as did the noble Earl, Lord Airlie. I, too, am chairman of a merchant bank which is a member of the Accepting Houses Committee and, as such, is included in the list of companies which are exempted from the Schedule 8 provisions of the 1948 Companies Act and which have up to now been allowed to have undisclosed inner reserves. If the principal conclusion of the Select Committee whose report we are debating today were to be implemented, then the accepting houses would be among the most affected, perhaps the most affected, of our financial institutions. Of course, I do not speak on behalf of the accepting houses as a body, but I am well aware of their views and I know of the concern which they have regarding the committee's recommendations.

In this connection, I must, I am afraid, say that I regard it as a matter of considerable regret that the committee, with its distinguished membership presided over by my noble friend Lord Plowden, did not call for oral evidence from the accepting houses. They heard the views of the clearing banks, of the accountancy profession, of a financial journalist who was an accountant, of a stockbroker and of representatives of the German banks. Of all these, only the last named were directly concerned in this matter of the provision of undisclosed prudential reserves. I am afraid the committee's report is in error in referring to the evidence of the accepting houses "through the British Bankers' Association". The British Bankers' Association is not in a position to speak for the accepting houses, and their witnesses explicitly disclaimed that they were so speaking.

I want to confine myself in my remarks to the matters of prudential, "inner", secret or undisclosed reserves, whatever one may call them, and then only to the question of principle; that is, of whether they are justified in the case of merchant banks. I do not speak for other financial institutions, which may well be in a different position from that of merchant banks and where, again, I venture to think—and this was clearly brought out in the excellent remarks of the previous speaker, my noble friend Lord Seebohm— despite the apparent uniformity, practices differ a great deal through valuation of assets and through provision for bad debts.

Thus one could debate, of course, a number of detailed questions that would arise if the directive which the Select Committee was examining were adopted; namely, for example, if secret reserves were to be permitted, whether they should be of the extent allowed by the draft directive, whether they should apply to all banking institutions or only to some, and whether they should apply to this item or to that item in the balance sheet. But, of course, none of these questions would really arise if the final conclusion of the Select Committee were adopted, because the committee completely rejects the idea of undisclosed reserves altogether.

I should like now to turn to the substance of this question. A financial journal, anticipating our debate today, described this as a debate between "progressives", on the one hand, and "defenders of the status quo", on the other. I am very happy to have the members of the distinguished committee whose report we are debating described as "progressives", and I do not myself mind, on suitable occasions, defending the status quo; but these terms and some of the emotional words that are associated with this issue and have been used in the media—and I fear to some extent even in this House today—are not best calculated to enable a sensible conclusion to be reached. The report, I am afraid, contributes to this by saying that the draft directive runs into conflict between the need for a true and fair view and the belief that it is necessary for banks to conceal their true profits and reserves.

I think it would be most unfortunate if it were thought that this was the distinction between what the Committee recommended and what, after all, has been the long-standing practice in the City of London. I hope that the Committee and, if I may say so, with humility, the speech of my noble friend Lord Benson today, will not carry with them the suggestion that what has been done, so far as the accepting houses are concerned, in regard to their accounts for decades in some way or other has not presented a true and fair view. It would be most unfortunate if that suggestion were to be accepted in respect of that most honourable segment of the City and one which has contributed as much as, if not more than, any other, to the preeminence of the City of London in the world of finance. But this is a point to which I shall return a little later.

When we come to the Committee's reasons for their conclusions, we find not a great deal beyond assertion in effectively two paragraphs, paragraphs 14 and 15. What are these reasons for recommending a departure from the existing practice in respect of the accepting houses. The first is that there is now a greater sophistication in the financial markets and less risk of misinterpretation of banks' financial statements that would undermine confidence. I am not sure what this means; but it seems to me to argue either way. Certainly, the sophisticated members of the financial community, for example those stockbrokers who regularly analyse the position of the merchant banks, are perfectly capable or arriving (as they have arrived for years) at an intelligent assessment notwithstanding the practice of inner reserves.

The report goes on in just one paragraph, paragraph 15, to give what appears to be one of its main substantive reasons. It says: meaningful comparison between one bank and another would be severely hampered if neither the profitability nor the net worth of the bank were disclosed ". And my noble friend Lord Benson made much of this in his speech. At one point he seemed to me to be saying that all banks are alike and indeed all enterprises are alike and the accounting practices must be the same for all of them. On the other hand, my noble friend Lord Plowden said quite clearly, if I understood him aright, that the draft directive is wrong in assuming that one bank is much like another and that flexibility is needed. Indeed, it is.

But what is this meaningful comparison that the report has in mind? One of the characteristics of the City is its high degree of specialisation. Are the committee thinking of comparing a clearing bank with a vast network of high street branches and with tens of thousands of employees, with balance sheet totals running into billions and engaging, notwithstanding the many changes in recent decades, essentially still in the business of deposit banks with an enormous number of customers and having what is known in the City as the endowment effect of substantial noninterest-bearing deposits, on the one hand, with a London merchant bank which probably has no branches at all, whose employees are numbered in the hundreds, who do relatively little "retail" business and whose activities in the highly risky capital markets, domestic and international, and in corporate financial advisory work, produce a totally different pattern of earnings, of profit-and-loss accounts and of balance sheets.

If, however, it is a question of comparing banks within the group of accepting houses, then the argument is irrelevant, once a fairly common practice exists among them. Or is the report, perhaps, thinking of comparing a London merchant bank with, say, a German universal bank—with whom, incidentally, we compete, as I am sure some noble Lords will confirm. Let us take the most formidable of them, the Deutsche Bank. That bank would be rather like a very large, at least, one very large commercial bank, with a huge branch network, a series of investment banks or merchant banks, and a whole series of stockbrokers rolled into one. Is this a proper comparison with a London merchant bank and, as already has been pointed out by previous speakers, the German banks do practice undisclosed reserves and will resist strenuously any change in their flexibility.

The report then says that to allow undisclosed reserves would "drive a wedge between Europe and America". This seems to me to be the most curious statement of all in this report. It is based, presumably, on the fact that there are no undisclosed reserves in the United States. Let us look at this. First what does the Committee mean by "Europe" in this connection? In paragraph 8 of the report—and my noble friend Lord Benson made this point—the Committee reviews the practice in different European countries. It shows that of all the countries in the EEC, only one, Denmark, does not permit undisclosed reserves. All the others do so in one manner or another. Outside the EEC, Switzerland, a not unimportant country in the world of banking also has undisclosed reserves; and so does another country which has now achieved a commanding position in the international financial community, Japan.

But even if the Committee were not thinking of the situation as it exists today in Europe but of some hypothetical situation in the distant future, when uniformity had been achieved in Europe, the statement is still very difficult to understand; for the draft EEC directive, such as it is, is, at any rate, a first attempt at such uniformity. It allows for undisclosed reserves and this the Committee rejects.

If we look at the other half of this curious comparison, the United States, we must remember how totally different is the financial structure there. First of all, it is largely governed by a multitude of statutes such as for example, the Glass-Steagall Act. Secondly, it is ruled over by the formidable Securities and Exchange Commission—and parenthetically perhaps I may ask whether the Committee "in order not to drive a wedge" between Europe and America would advocate the setting up of such a Commission in this country and in Europe generally. But the functions of the different parts of the financial community are quite different from ours.

Let us take, for example, the Wall Street investment banks—I suppose, the nearest equivalent to the London merchant bankers'—we find, first of all, that many of them are partnerships so that the present debate does not apply to them; and, secondly, the range of their activities is quite different. For example, while they are, or can be, members of the stock exchange, merchant bankers are not and cannot be. On the other hand, Wall Street houses do not do the sort of banking, business such as lending through advances and acceptance credits and so on, which the London merchant banks do and which approximate to the commercial banks.

The case for inner reserves as far as the accepting houses are concerned, is essentially a simple one. If I repeat what was said by the noble Earl, Lord Airlie, and perhaps will be said by the noble Earl, Lord Limerick, I apologise, but it cannot be said too often. Transfers to and from inner reserves are used to smooth to some degree—it cannot, in the nature of things be more than that—the fluctuations in the financial conditions of merchant banks which are, or can be, large because of the nature of their businesses. This fact was recognised by at least one of the members of the committee when examining witnesses from the British Bankers' Association. My noble friend Lord Plowden has said that fluctuations are common in other businesses, too. Indeed, they are; but in his introduction, he, himself, made it clear that he believes banks to be different from industrial companies, and this is one of the reasons why the gap left by the fourth directive may need to be filled.

The merchant bankers' lending portfolios tend to consist when compared with the large commercial banks of a relatively small number of relatively large loans. In addition, much of their other business, such as underwriting in highly volatile capital markets, adds a further substantial risk element which in each case is large in relation to the total volume of their business. It is when one or other of these relatively large risks materialises that the ability to smooth, not to eliminate, the trend of profits becomes important.

My Lords, I am sure that the painful memory of the Rolls-Royce calamity is still present in your minds. The accepting houses were heavily involved. Would it really have contributed to "a true and fair view" if the initial loss had been fully accounted for when it was first revealed, rather than partly or wholly to have been covered by transfer from inner reserves, these being replenished—by instalments over about three years—when the book loss was finally recovered? I venture to think that the practice then adopted gave a much truer and fairer view of the conditions of the accepting houses and their business than would otherwise have been the case.

There is, however, another point of great importance to which I must draw your Lordships' attention, and that is the role of the supervisory authority. The accepting houses arc under continuous close supervision by the Bank of England. Their special status, perhaps today not quite as exclusive as it once was, is matched by a very stringent oversight, covering every aspect of their activity, including management. I must say with all possible respect to my noble friend and his eminent colleagues that I am amazed that nothing whatever is said in the report about supervision, although the subject was referred to a number of times in the examination of witnesses.

There is no section of the financial community of the City of London, I venture to think, that is more respon- sive to the governor's eyebrows—and more than the governor's eyebrows are often involved—than are the accepting houses.

There is a great deal more than can be said, but I should like to finish on one very general point which I regard nevertheless as being of crucial importance. Even the staunchest supporters of the European Community—and I count myself among them—will from time to time have had the fear that the standardising, harmonising and unifying zeal of the Commission may be excessive.

Here, however, we have a draft directive which, whatever may need to be done about some of its detailed provisions, contains the elements of a sensible compromise between different laws, traditions and practices in the countries of the Community. As such it was, I understand, defended recently in a meeting in London by the Commissioner responsible for it. I am greatly tempted to believe that the pragmatic approach to this question which is evidenced by the Commission in this draft directive had something to do with the fact that the Commissioner in question is British and served for a number of years in another place as a most distinguished Member for the Cities of London and Westminster. In all sincerity, I must say to my noble friend that it is a great pity that this committee should have chosen to respond in so rigidly dogmatic a manner. I profoundly hope—indeed I strongly urge—that those who will have the task of discussing these matters within the institutions of the Community, will not be guided by such doctrinaire views.

Lord Bruce of Donington

My Lords, before the noble Lord sits down, would he be good enough to clarify one point? He will be aware that Article 37 of the draft directive in question proposes a limitation to these various transfers to and from secret reserves. His own speech does not indicate whether he accepts this 5 per cent. limitation as proposed by the Commission, I wonder whether he would kindly answer that point?

Lord Roll of Ipsden

My Lords, I will attempt to do so. I quite explicitly tried to avoid going into the details. I said—the noble Lord will recall—that there are many questions of detail that will need to be discussed; namely, what should be the extent? Should it be applied to all financial institutions? To what items in the balance sheet or in the profit and loss account should it apply? I was concerned primarily with the principle, and indeed only with the principle, as applied to the accepting houses.

6.25 p.m.

Lord Cobbold

My Lords, first, may I add my congratulations to the two maiden speakers today? The noble Earl, Lord Airlie, put very clearly and strongly the points which were made to us by the Accepting Houses Committee, and I am sure it was of great value to hear it from so distinguished a member of the Accepting Houses Committee. Also, the noble Viscount, Lord Chandos, gave a "happy fairy" commendation to the Bank of England. I shall be returning towards the end of what I have to say to the Bank of England's position regarding some of these matters. May I take up one point on the speech of the noble Lord who has just preceded me. He said that because of some of the rather rough things that have been said today some may leave this Chamber thinking that the accepting houses had not performed as a very admirable part of the City of London or had not enjoyed great respect for very many years. I can assure the noble Lord that nobody leaving the House is likely to have any doubts on that point. I may speak for myself, I most certainly have no doubts on that point.

I am afraid that I am bound to be a little repetitive of what was said by the noble Lord, Lord Plowden, and others because this argument covers the same ground. I will be as short as I can. The draft directive proposes in Article 37 that banks should be allowed to keep a percentage of undisclosed reserves. We have felt and percentage of undisclosed reserves. We have felt—and it has been supported by a good deal of what has been said today—that that would be going back both on the "true and fair" conception of the fourth directive, though I agree with the noble Lord, Lord Lever, that the truth of the "true and fair" is not always very easy. Still, it is also moving backwards, away from the general movement over the past 20 to 30 years—certainly in this country—towards fuller information and more sophisticated accounting.

We felt that that was a pity and in paragraph 15 the report suggests that Article 37 of the directive should be deleted. But, from evidence received, it seems likely that in various EEC countries—certainly in Germany—there will be support for Article 37 or something like it. The committee have taken the view that the right policy, if harmonisation is to be achieved, is to work towards a uniform "no undisclosed reserves" régime. This would be in line with the present policy and practice, as has been stated, of the London and Scottish clearing banks. The committee recognise that there will be many points of accounting lay-outs which will need adjustment to meet particular cases. There will in any case be a general need for much mare flexibility in the directive and also far more clarity and harmony between the fourth directive and the draft directive we are now considering.

Obviously, there are many differences in banking practice and accounting practice in different EEC countries—harmonisation is bound to raise many difficulties large and small. The committee were glad to hear in evidence from the British Bankers' Association that a lot of useful discussion on technical points was taking place between banking representatives in the various member states.

Long discussions seem inevitable. If—and one must repeat "if" —it proves possible to build a Common policy on the lines recommended in the report, it would have the advantage not only of uniform practice in the member states, but also of bringing Common Market practice into line with North America. That is surely an important point. I accept what the noble Lord just said: banking is a little different the other side of the Atlantic from what it is here but it is an important point.

I turn to the difficult question of possible exemptions from the draft directive. The London Discount Market and the Accepting Houses Committee put forward strong arguments for exemption, both on the grounds of their specialised functions and of the practical difficulty of fitting their accounting procedures into the requirements of the directive. The special accounting problems of the discount houses are referred to in paragraph 22 of the report.

After hearing quite a lot of evidence from both banking and non-banking sources, the committee have concluded, as the House knows, that though these arguments are of great importance to their proponents, they are outweighed by the view that the right objective is a uniform "no undisclosed reserves" régime which, as I have said, is in line with the practice of the clearing banks. If any exemption were given it would be difficult to maintain that it should be given to some categories and not to others. This might raise difficulties on the home front and it would certainly raise them on the Common Market front as a whole.

It was made clear in evidence that practice varies a great deal in different EEC countries, especially in Germany, where a special need for latitude (largely for historical reasons) was argued by representatives of German banks. A wide extension of exemptions to various categories in various EEC countries would surely lead to confusion and to the feelings of unfair competition which it is the object of the directive to avoid.

There have been suggestions in the press, and to some extent today, that a "no undisclosed reserves" régime might have adverse effects on the credits of of some institutions, particularly the smaller ones. On this point, I would have the following comment to make. Bearing in mind the development in recent years of Bank of England supervision of the banking community and also the history of the 1973–74 banking troubles, it would seem most unlikely that any bank of importance would be allowed to fail. This seems to me to have particular force in the two categories which have argued for exemption: the discount market, with its special functions and intimate connection with the Bank of England, and the accepting houses with their very close connection with the Bank of England. It is impossible to go into the very many matters of technical detail covered by the report, but there are three such matters which I think should be on the record in this debate, two of which were mentioned by the noble Lord behind me. One was, in paragraph 23, the proposal—considered by the Committee to be "entirely misconceived" —that banks based outside the EEC might be required to publish the accounts of their EEC branches, which seemed to all of us not to be a good idea.

There are two points in paragraph 27: first, the problem of how to deal with set-offs and, secondly, the use of residual rather than original maturity in valuations. These are detailed points, but important ones. To quote from the final paragraph, paragraph 28, of the report: it is also clear that there are wide differences of practice and philosophy between Member states. Much work remains to be done in the Council working party if all the problems are to be satisfactorily resolved ".

6.33 p.m.

The Earl of Limerick

My Lords, may I add my voice to the others that have been already heard raised in admiration of the two maiden speeches this afternoon from my noble friend Lord Airlie and from my noble colleague, if I may so describe him, Lord Chandos, sitting opposite. I hope that the style of oratory we have heard from them today we shall continue to enjoy in the future.

As befits one who comes all too infrequently to your Lordships' House, I will confine myself to a single topic, with only a passing word of approbation for the Select Committee's distrust of accounting by putting figures in boxes. From the beginning of this debate, I have been a great supporter of the auditor's discretion and of the "true and fair" concept, to which I shall revert in relation to the second point I shall refer to—that of the inner reserves of the eight scheduled banks.

I should like to echo the regret expressed by the noble Lord, Lord Roll, that there was no oral evidence at all from the accepting houses in the consideration of the Select Committee's findings; but it will not have escaped remark that the accepting houses do not lack personal advocates in this House; and at this stage, it would be right for me to remind the House of my interest as a director of one of the accepting houses, and indeed as a chartered accountant who, for a period was responsible for the preparation of their accounts. In that capacity, I had cause to think about the nature and magnitude of the risks with which this debate is concerned. This was 10 years ago, and I think that the risks are more, rather than less, daunting.

We should ask: Why are our banks different from other companies? Confidence is the point which has been stressed—and rightly, in my view—as being paramount. Confidence in the stability of banks is more a matter of public concern, and the effects of failure generally are more damaging than for non-banking companies. And, having been in countries where there was a collapse of confidence in the banking system, it is not a situation I would wish to see in any country, least of all Britain.

Secondly, the public and perhaps most of all the politicians expect of British banks two quite contradictory things. They expect, first, that they should be as sound, to coin a phrase, as "the Bank of England". Secondly, they expect them to be more adventurous than they are commonly thought to be in certain ways—first, in the mounting of rescue operations, which may involve an equity element, risk capital, supporting ailing industries in the public interest and in the interest of maintaining employment. Secondly, they would be required to be more adventurous in providing venture capital for support of new businesses and, thirdly, in foreign lending, whether on private or sovereign risks, in support of our export trade. In all these areas, banks are being exhorted to be more adventurous than perhaps their commercial judgment would always lead them to be.

To go one stage further, since the clearing banks have no longer found it necessary to claim the exemptions of the eighth schedule, why should it be thought necessary that the accepting houses should continue to do so? I think the reasons were given very properly and forcefully by my noble friend Lord Airlie and therefore I will not repeat them in detail. I think there is a persuasive argument in the ants and the elephants. I think we all recognise that there is more excitement in all quarters over one rogue elephant than there is over 10 rogue ants. These things are prominent in the accounts of the accepting houses in a way that they are not in the clearing banks. But I believe there is a more substantial point, and it is one which was first raised by the noble Lord, Lord Lever. I should like to pursue this: it is the question of the valuation of the stock in trade. The commonest debate between a company and its auditors concerns the value of its stock. The commonest speculation of financial commentators probably concerns stock valuations. Every audit involves an element of discretion—a point which was very well made by the noble Lord, Lord Roll, in commenting on the interesting speech of the noble Lord, Lord Benson. At the end of the day it is a matter of judgment as to what is "true and fair"—and long live the "true and fair" concept.

In 1973, I was somewhat involved in the early European skirmishings, trying to establish the acceptability of this concept, and my faith in its importance has in no way diminished. But surely the point is this: the noble Lord, Lord Benson, based his powerful speech on the principle of "the whole truth", and I thought it was just a little detracted from by overstatement. He was really basing his argument in on the fact that banks should be made equal with other companies. However, the mere withdrawal of the eighth schedule would not make banks equal with other companies, but less equal. They would be in an unequal position.

Why do I say that? I say that, because the normal basis of stock valuation is whichever is the lower, cost or market values. The auditors in a manufacturing or trading business will accept the commercial view of the directors as to the value of the company's trading stock—which was a point made by the noble Lord, Lord Seebohm—but what is the loan portfolio of a banker but his trading stock? And why should bankers be less equal in claiming a judgment that the market value of their loan stock, looked at item by item or overall, in given circumstances may be less than its cost—namely, the amount of currency originally advanced? This would be to put them in a less equal position.

There is also a curious belief that the building up of inner, or prudential, reserves is an end in itself, or, perhaps, a devious plot to conceal the truth, to the detriment of depositors, shareholders, employers, employees, stockbrokers, financial journalists and Uncle Tom Cobbleigh. But, surely, it is better for the prudent banker—and prudence is the first requirement by a depositor of his banker—for him to risk understating his principal asset, his loan portfolio, or understating his annual profit, than to risk overstating either of these items. The truth comes out in the end. It is better to be prudent.

I would further argue, from some personal experience, that the effect of the eighth schedule is considerably exaggerated. I say that for three reasons. First, there are very well-established accounting conventions which severely constrain the creation and use of inner reserves. Secondly, the Bank of England, as the regulatory body, exercises its own strict supervision. Thirdly, and I think most persuasively, there are compelling commercial reasons why inner reserves will never become absolutely very large, simply because it would be commercially stupid to allow them to become large. Banks rely for their funds on their depositors, and the accepting houses rely substantially on other banks, as their source of deposit funds. Therefore, the substantial understatement of profits, and substantial understatement of net worth brought about by the creation of these inner reserves, would be a plain act of self-denial, restricting the ability to trade.

I come now to something which my noble friend Lord Camoys has not yet said, but which I suspect he may be going to say, judging from a reading of the red book; that is, that in some ways, the existence of prudential reserves constitutes a licence to over-trade. Not so, my Lords—quite the contrary. Banks, especially foreign banks—certainly, those dealing with mine—do not deal on what they guess our inner reserves to be, or on some journalist's assumption. They give us credit for what they see on the face of our audited accounts. If that is understated, it is an act of self-denial on our part and not one which we are likely to overplay. Secondly, they rely immediately on the known supervision of our banking system by the Bank of England, but that point, happily, is not at issue.

So far, I have concentrated on loans, but there are other considerations which have not been mentioned much this evening, all of which affect the accepting houses to a greater degree, at least, than the other banks. I refer, first, to interest rates. Sudden fluctuations in interest, such as we have seen in recent years, have a certain rather startling effect. First, the economic climate may change, the likelihood of repayments being made on time may sharply diminish and the number of bankruptcies may sharply increase. Therefore, there is a risk for capital or, at least, a risk for funding. Secondly, the bond portfolios held by banks may vary very sharply in price in a short period.

Thirdly, violent movements in exchange rates are often associated with these movements in interest rates, and exchange rates are, on the whole, weak when interest rates are high, so the effect is compounded. Fourthly, the increased cost of the shorter-term funding of a loan portfolio when interest rates rise can be quite dramatic until it has worked its way through the system. All of these may have a big impact on annual profit.

Then there is another category of risk with which the accepting houses are much concerned; that is, contingent liabilities. I shall single out just two cases. The first is the obvious one of acceptance credits—not allowed for at all in the commission's consideration—where a lot of the credit given to customers is not by way of direct loans, but by way of lending a name, but with no less risk attaching to the signing of the bill of exchange. Then there is the area of bonding. Banks may be liable for non-performance of their bonded customers, often for very large sums. Here there has been a reiterated plea for the banks to be more broadminded, more far-seeing in the way, in which they treat their bonding liabilities; not to regard them merely as if they were the equivalent of an overdraft, but to treat them more on an underwriting basis. If they are to do that, then there has to be some consideration for the risk involved and of the impact of the calling of a very large bond on one of the bank's customers.

Yet another category—that of political lending—has already been alluded to this evening. There may be countries in trouble—we have the current case of the Polish debts—there may be industries in trouble, where banks are asked to give special consideration to rescue packages, in the interests of the national wellbeing or employment, and there is the area of venture capital. In all these areas we have some conflict between the duty of the banker, as he would see it, to use his depositor's funds prudently—as the depositor has a right to expect—and his own feeling, and the feeling that is constantly being urged upon him, that he has some other duty in the national interest to use them in a more adventurous way. This conflict which can best be reconciled if there is a basis for smoothing the unduly large impact on a given accounting year of a rogue elephant, or, maybe, two or three rogue elephants who get loose in the same accounting period.

I shall endeavour to come to a conclusion, which is that the EEC roposals—Article 37 and the 5 per cent. formula related to loans—is a compromise and, in my judgment, it is an inelegant one. The figure of 5 per cent. is unnecessarily large to achieve the purpose that is in mind in relation to a loan portfolio—considerably too large—although, if banks who are lending a substantial amount of their credit on bills of exchange, on acceptance credit, had to take that into account, you would have to apply some factor to that 5 per cent. But worse, perhaps. this formula offers no scope for considering the value of the non-lending risk assets, which are very much part of the business, the daily stock in trade, of the accepting houses.

So I do not delude myself that the eighth schedule will abide forever, nor, personally, with, two provisos, would I greatly regret its demise. The first proviso is that bank directors, as the directors of other manufacturing, commercial and trading companies, should have reasonable discretion, supervised by their auditors and the Bank of England, in the year-end valuation of their risk assets, including their loan portfolios. The second proviso is that some formula not for concealing the truth, but for spreading the impact of the more volatile profit and loss items over more than one accounting year, should be agreed upon and adopted as common accounting practice. Meanwhile, although I do not believe that the Article 37 formula is a particularly suitable substitute for the eighth schedule, I suggest that this whole subject merits a lot more attention, before we conclude that this compromise, imperfect as it is, should be rejected and that the eighth schedule banks should have no ability at all to deal with these very difficult questions.

6.48 p.m.

Lord Camoys

My Lords, I should like to thank the noble Lord, Lord Plowden, for providing the opportunity for this debate and for the way in which he has presented the conclusion of the Committee, on which I was privileged to sit. Like others, I must declare my interest as a merchant banker, though not one involved with any member of the Accepting Houses Committee. But I should like to emphasise that the views which I express—and they may be fairly forceful—are my own and are not necessarily those of my employers. I should also very much like to congratulate the noble Earl, Lord Airlie, and the noble Viscount, Lord Chandos, on their maiden speeches. I admire them very much for having chosen a contentious subject, and they have shown great courage in doing so. I also admire them for the beautiful way in which they presented their arguments. I hope that the noble Earl will forgive me if I put rather different views. I am sure, however, that he will agree in the words of Mark Twain that it were not best that we should all think alike: it is difference of opinion that makes horse races"— and, one might add, fees for merchant bankers.

I think that the report is very sensible and, while I believe that each of the conclusions is important, I, like many others, will confine my comments to the first conclusions; namely, that banks should not be permitted, as some in this country now are under Schedule 8 to the Companies Act, to maintain undisclosed reserves, by whatever means, whether by undervaluation of loans, money market assets or investments. One reason why I believe this issue to be important is that under the Companies Act 1981 I understand that it is open to licensed deposit takers as well as any recognised bank incorporated in this country to apply for Schedule 8 exemption. In theory, therefore, the number of deposit takers who could maintain undisclosed reserves in future could escalate quite dramatically. Therefore, the progress, as I would see it, that has already been made in this area of disclosure could be more than turned back.

Most important and first, however, it seems to me to be fundamentally irrational for this directive to suggest that all banks within the EEC should be allowed undisclosed reserves up to 5 per cent. of their loan portfolio and yet stipulate that this draft directive should, as has been said before, be read in conjunction with the fourth directive, which specially insists that all businesses should provide accounts for their users which present a "true and fair view" of the business. Amazed by this inconsistency I turned to my dictionary where I read: True, in accordance with fact, not erroneous, representing the thing as it is". And: Fair, just, unbiased, equitable". Yet if this directive is implemented as it stands, including Article 37, banks will be able to undervalue their loan portfolio by five per cent., a figure which could both equal published capital and reserves and enable smoothing of published profits by the equivalent of as much as three or four years' average profits. The potential degree of smoothing is therefore vast and in my view could let through at least 10 rogue elephants.

Among the large amount of evidence that was heard it became clear that three groups were most vociferous in seeking to hang on to the privilege—a doubtful privilege, in my view—of maintaining undisclosed reserves, claiming, as we heard from the noble Earl, Lord Limerick, that in fact the directive was too limiting in that respect. I must confess that my understanding of German philosophy and psychology proved to be too limited.

So far as the discount houses are concerned, here I agree with what the noble Viscount, Lord Chandos, said. We now have ample evidence that the revelation of true losses, even when they are very large, does not produce a panic in the financial system. But it is on the arguments of my friends, and I admit competitors, in the accepting houses that I shall concentrate. Their written arguments are more accurately expressed in the body of the report but I hope noble Lords will forgive me some licence if I say that my understanding of their argument is as follows.

Accepting houses, for historical reasons, have relatively modest capital bases. We deal in a relatively small number of very large transactions and as a consequence our level of risk is higher than for many other banks whose risk portfolio is more widely spread. Our profits are unpredictable and therefore subject to great fluctuations. For this reason our position is made the worse because we have to produce accounts every 12 months, which is an awkward period. Our relatively few large customers sadly cannot be trusted with true figures since they might take fright if they are volatile. Consequently, in order to avoid the risk of a banking crisis and our shareholders losing money, we have to smooth profits by way of undisclosed reserves. That way, nobody really knows how much true capital we have and we are able to trade at a higher level than would otherewise he possible. That is not over-trading because the Bank of England keeps an eye on us, as they do on the discount market. Further, it is in the nation's interest that we be protected from the cold wind of having to produce full accounts since we have been the innovators in the banking industry and we have been the competitive force.

While I fully accept that it is in the public interest to preserve public confidence in banks, and particularly those which are well run, I personally cannot accept that the accepting houses have made a sustainable case for the maintenance of the present position. In making their case they ignore the fact that there are now many banks—not only clearing banks but their merchant banking subsidiaries—carrying out similar lines of business who, to date, have survived quite comfortably without this privilege.

Although I have the highest regard for the accepting houses and their management, it must be pointed out that no longer are they the only innovators in our banking industry—if ever they were. Certainly they did provide competition, and still do, but so do many, many others. With only some 4 per cent. of the deposit banking business in this country, the competitive point cannot be that important. Indeed, in 10 years their share of the deposit market has halved. So far as the particular types of risk which concern them so much are concerned, they do not have to take those risks. They are not under any obligation to do so. If they can only do so with the advantage of, as they would sec it, hidden reserves, I suggest that is not perhaps the best basis, becasue, as we know, those hidden reserves could disappear without any of their customers or users knowing it.

So far as advisory services are concerned and where the accepting houses are still obviously very successful, I cannot think of any service which is not carried out by banks who do not have hidden reserves. Further, I still do not even know why hidden reserves are necessary to be innovative. Indeed, if a case can be made, in my opinion it would be much better made by a manufacturer than by a service industry.

Quite obviously I believe that the accepting houses in their evidence are just possibly overstating their importance in the banking industry today. Times have changed. They are very efficient but not unique any more. In their concern, I believe that they belittle themselves and, rather strangely, as the noble Lord, Lord Benson, said, they have certainly belittled their few large customers. Perhaps I should add that if I was one of those not considered to be able to read their full accounts responsibly, I would certainly consider moving my business elsewhere. The noble Lord, Lord Roll of Ipsden, emphasised the obviously very important role carried out by the Bank of England in its supervisory position. May I make one point, but very gently: that the discount market would claim that they are equally closely supervised. I think recent experience perhaps demonstrates something there.

I said earlier that I fully concur with the view that confidence in banks is vital to the nation. Having been a banker during the secondary banking crisis and having seen the calm reaction to the publication of very bad losses which have been mentioned tonight, I certainly conclude that banks now operate in a sophisticated environment which expects and requires full disclosure and which can cope with that responsibility. I cannot believe that an accepting house would not be able to brave the realities of genuinely true and fair accounts. Rather I believe that ignorance of the true situation and the consequential risk of rumour are much more dangerous. Ignorance is not bliss. It is dangerous.

In so far as the draft directive legislates for undisclosed reserves, it is a bad one. It contradicts another and is one of those which is liable, in my opinion, to bring EEC directives, draft or otherwise, into disrepute. The business of banks, as we all agree, is based on and all about credibility. Hidden reserves and their use, in my opinion, do not increase credibility—rather the reverse. I strongly commend the report to your Lordships.

6.58 p.m.

Lord Redesdale

My Lords, so much has been said already about disclosure that I feel I should start by disclosing an interest—that I work for an American bank. May I go on to congratulate my noble cousin the Earl of Airlie on an excellent speech to which I listened with considerable interest. But I have to confess that I did not agree entirely with everything that he said. I should also like to congratulate the noble Viscount, Lord Chandos, on an equally fine speech. I found that I agreed with him rather more. My congratulations go on to include the noble Lord, Lord Plowden, and his committee on producing such an excellent report with which I totally and wholeheartedly agree.

May I ask your Lordships' indulgence in listening to a few comments that I should like to make at the end of a rather long batting run. However, we are in the home straight and I shall be very brief. Therefore, your Lordships can breathe a sigh of relief. The point I wish to raise and emphasise primarily is the requirement for branch accounts for non-EEC banks. I wholeheartedly agree with the view of the committee. I believe that branch accounts would be misleading, discriminatory and have a very negative effect on London as a financial centre.

First, why should it be misleading? The argument for branch accounts is that they would give sufficient information to give confidence to local depositors and investors. But branch accounts cannot give a true picture. What does count are full accounts of the parent bank, since it is the overall condition of the bank that allows the investor or the depositor to judge just how sound an institution it is.

American banks have far greater disclosure than European banks, as so clearly stated by the noble Lord, Lord Benson, in his excellent speech. Most American banks with branches in the EEC take great pains to publicise their full accounts in Europe, a point I can personally vouch for as publicising the accounts of my bank is one of my responsibilities. Many of the non-European banks have stock quoted on European stock exchanges, so anyway most of them have a statutory responsibilility to publish their accounts.

My second point is that the requirement for branch accounts would be discriminatory. First, would branch accounts provide the necessary information for investors and depositors? The answer is no, because it is only the total accounts of the parent body that give sufficient information for the investor to judge just how sound an institution it is. In fact, the sort of information that would be produced would really only be of use to competitors, not to investors.

The third point is that it could have a harmful effect on London as a financial centre. There are far more non-EEC banks with branches in London than such banks in any other European capital. I must emphasise that I am talking about non-EEC banks in Europe. If your Lordships will bear with me I will give the figures, just to give some idea. Non-EEC banks with branches in Europe: Belgium 16, Denmark 4, Eire 5, France 44, Germany 45, Italy 14, Luxembourg 9, Netherlands 16—but the United Kingdom 170. So the main force of this directive would affect London.

Finally, I agree with noble Lords who believe that full disclosure is necessary. The argument used in Germany was that confidence had to be created to overcome those memories of runs on banks in the 1920s, and that smoothing is totally necessary. I think this is a fallacious argument, because back in the 1920s there were a considerable number of runs on US banks, and as a result legislation was required to ensure full disclosure. Since then American banks have gone from strength to strength. So surely full disclosure would probably have a very healthy effect on banks in Europe.

7.3 p.m.

Lord Bruce of Donington

My Lords, we have had a very long and interesting debate, and it is my first duty and indeed pleasure to congratulate the noble Earl, Lord Airlie, on his maiden speech, which, if I may say so, was delivered with obvious technical knowledge, was set out with very considerable logic, and was indeed very pleasant to listen to. I would like also to congratulate the noble Viscount, Lord Chandos, who also addressed the House in very persuasive terms, and, if I may say so, with a degree of modesty which seemed to belie the depth of knowledge which he showed of his subject. I am sure the whole House will be looking forward to receiving early and frequent contributions from both noble Lords.

The House will be particularly grateful to the noble Lord, Lord Plowden, and his committee for the very comprehensive and detailed report they have prepared on draft Directive 5692/81. It is quite clear that they have gone into the subject most thoroughly. Anyone who reads through the detailed proceedings will see the persistent questioning, the persistent desire to clarify many technical points that arise on a subject of this kind. I am sure your Lordships would wish to congratulate all members of the committee, and in particular Lord Plowden, for the service they have performed.

Inevitably much of the discussion this afternoon and this evening has gone on to the whole question of the propriety or otherwise of creating and maintaining and altering hidden reserves. My noble friend Lord Lever pointed out some of the difficulties in arriving at what is called a "true and fair view". The noble Lord, Lord Seebohm, went so far, I believe, as to challenge the whole concept of true and fair by saying, what could be meant by "true and unfair" or "untrue and fair"? Perhaps I can best encapsulate all this by saying that it is possible for accounts, or indeed a report, to be quite truthful in every particular, and yet in telling the truth, if some part of the truth is omitted, it becomes unfair. A report can be technically true but it cannot be both true and fair unless there has been a full and adequate disclosure of all the facts that have a bearing on the accounts that are being reported on, or the accounts that are being published, or the report that has been made. By the same token, a set of accounts that are untrue, or a report that is untrue, cannot in any circumstances be fair.

This, I believe, is the stand that is taken by the profession to which I have the honour to belong. Your Lordships will have seen, and I hope will have read, the evidence that was given by the Consultative Committee of Accountancy Bodies on this subject. Your Lordships will find that they come out quite unequivocally that there should be full disclosure. If I may say so, the point was made even more forcefully in the elegant and strong, and, if I may say so, brilliant contribution to the debate by the noble Lord, Lord Benson, who I believe spoke for the entire accountancy profession in laying down with such devastating clarity exactly why there should be an insistence on full disclosure. I do not think the noble Earl, Lord Limerick, need look any further when expressing his support for, as he quaintly put it, spreading the load or spreading the impact by non-disclosure. He need do no more than re-read the speech that was made by the noble Lord, Lord Benson.

The committee came to their conclusion, after listening to all the evidence, in the terms which appear at paragraph 15 of their report. It says: They have concluded that banks should not be permitted to maintain undisclosed reserves, and that Article 37 should be deleted from the draft directive. They recommend that the United Kingdom delegates press this view strongly in the forthcoming negotiations ". I should like to add force to that very moderately expressed opinion. I not only think that the United Kingdom delegates should press this view; I think that the United Kingdom delegates should insist on this view to a point where, if it is not agreed with by the remaining EEC members, they should decline to pass the directive. There should be an insistence on this point. As has been pointed out by many noble Lords, there really is not a necessity for this directive at all. It does not really confer any profound benefit on member states of the European Community. The fortunes of ordinary people in each of the member states are not going to be vastly shaken by the fact that the accounts of the various banks in the various countries are not to be standardised. I do not think that it will really have a profound effect upon their lives.

I agree with the view that the EEC could concern itself with far more important matters than this which is very peripheral. But if we are required as a country, and our representatives are required as a country, to hold consultations at COREPER level in councils and if, after taking into account the views of the Economic and Social Affairs Committee and after taking into account the views of the European Assembly, they are required, ultimately, to state a view upon this subject, then I think that unless Article 37 is deleted completely, the representatives of the United Kingdom should have no part of it at all. That will, of course, not absolve the United Kingdom Government in due course, when it thinks that there is some priority to be accorded to it, so to legislate within the United Kingdom in order to accomplish the final step which the report envisages—in other words, the complete disclosure and the prohibition, in effect, of the creation of secret reserves. This may happen, and as and when it does happen we on this side of the House will give it fair wind. In the meantime, we suggest that there are far more grave and important priorities affecting the vast number of people of this nation to be dealt with first.

I would not wish, particularly at this time of night, to go over again all the matters that have been dealt with in the report and which have been so ably dealt with by the various noble Lords wh0o have spoken this evening, most of whom, of course, are expert in this field. In fact, save for my own role as an accountant, I feel very much like an amateur among professionals. But I remain, as indeed I believe my profession will remain, firmly and clearly in support of the fact that there should be, at all times, applicable under all circumstances and to all concerns, the requirement for accounts to be drawn up and for an auditor's report to be made upon them and that they, together with the notes, the schedules or whatever else comes with the accounts, should show a true and fair view.

I cannot believe that there will be any significant movement in the country which would seek to reverse not only the opinion of the select committee, but also the views of the accountancy profession as so clearly set out by the Consultative Committee on Accountancy Bodies. But if, peradventure, this subject does find itself high on the list of Government priorities, if—to be mildly controversial—they find that one way of filling in time might be to introduce a measure of this kind, then may I ask, I think with the support certainly of the accountancy profession, that if legislation ultimately results from the passing or agreement to this draft directive in whatever form it ultimately materialises, it be not by statutory instrument but be by a separate Act of Parliament? I gave notice to the noble Lord that I was going to raise this aspect of the matter, because I think it a matter of some importance.

When judges come to consider the litigation arising from the Companies Act 1981, which as your Lordships know was rushed through this House in its concluding stages, they might well have time to reflect that it would have been far better had your Lordships' House been able to subject it to the same kind of meticulous examination that the Select Committee on this occasion have devoted to the annual accounts of banks. So if there is to be any legislation resulting from any finally agreed version of this draft directive, we would hope that it would be by a Bill rather than by a statutory instrument, so that some detailed examination of it can take place and so that if necessary some amendments may be accepted.

I conclude as I commenced by congratulating the noble Lord, Lord Plowden, and his committee and once again emphasising my own pride, as a professional accountant, in the magnificent speech that was made by the noble Lord, Lord Benson, with which I agree 100 per cent.

The Earl of Limerick

My Lords, before the noble Lord, Lord Bruce, sits down, I do not know whether he heard the whole of my speech, but as a fellow accountant will he address himself to the question that I raised, which was that the directors of banking companies should have at least the same discretion as the directors of manufacturing, trading or commercial companies in assessing the value of their stock in trade —namely, in this case their loan portfolio—and should have the same ability to convince their auditors of a proper valuation of that stock?

Lord Bruce of Donington

My Lards, yes, I am happy to answer the noble Earl's question. I entirely agree that bankers should have the same opportunity as is afforded to the directors of manufacturing companies in the valuation of their stock. The problem is not so much the convincing of the accountants, although as a profession we normally check very meticulously indeed all kinds of stock. That is not the question. It is not the question of being prudent. It is the question as to whether or not the prudence should be disclosed. That is the problem; not the act of valuation itself or its accuracy; it is the provision that is made. If the provision is a proper one and is prudent, our view is that it should be disclosed. That is all.

7.21 p.m.

Lord Trefgarne

My Lords, it is an extraordinary thing that the debates which follow reports of the noble Lord, Lord Plowden—very often introduced by the noble Lord himself—bring forward a fine array of maiden speakers. I recall that some years ago the nobel Lord headed a committee which inquired into the future of the British aircraft industry, and I recall that I made my maiden speech in your Lordships' House upon that debate. Today we continue the tradition with the maiden speeches of my noble friend Lord Airlie and the noble Viscount, Lord Chandos.

I have a particular link with the noble Viscount, although he may not know it, because my father served under his grandfather in the Coalition in the last war when the noble Viscount's grandfather was, I think, the Minister of Supply in that famous Administration and my father was the humble Parliamentary Secretary in the same department. I cannot claim the same links with my noble friend Lord Airlie, but I must say that the two maiden speeches which we have heard today were of a particularly high standard, and, like other noble Lords, I look forward to the intervention of both noble Lords again very soon and often thereafter.

First, I should like to add my voice to those of your Lordships in congratulating the Select Committee on an admirably clear and forthright report, and on the expert way in which the noble Lord, Lord Plowden, introduced and amplified the report in his opening remarks. Your Lordships' committee has taken a keen and valuable interest in the various elements of the Community's programme for the harmonisation of company law. In matters of accounts, for example, which are particularly relevant in the present context, it made substantial reports on the fourth directive (on individual company accounts) and on the seventh directive (on group accounts). In both cases the reports were, and indeed still are in the case of the seventh directive, of considerable benefit to the Government in the conduct of negotiations in Brussels.

I should like to add that it is not just the reports themselves that are so valuable but the evidence taken as well. Of course, the Government have their own sources of information and, indeed, make a point of consulting very widely with interested parties outside Government. But the expert and highly pertinent questioning by your Lordships' committee certainly succeeds in eliciting illuminating replies from the various organisations and individuals who respond to the committee's invitation to give evidence.

As the report states, the draft directive on the annual accounts of credit institutions is a sequal to the fourth directive. That point has been made by more than one noble Lord this evening. It was envisaged when the draft fourth directive was first published in 1971 that such accounts would have to be dealt with in a separate directive, and Article 1(2) of the fourth directive, as adopted in 1978, permits member states not to apply the provisions of the directive to banks and other financial institutions pending subsequent co-ordination. The draft directive is the fruit of extensive consultations which the Commission has had, particularly over the period since the adoption of the fourth directive, with specialists in this field in the Community and indeed with member states. However, it was only adopted as the Commission's formal proposal in March of last year. No one is committed to its contents, and it is only now that the legislative process in the Community will get under way. I shall touch on the point raised by the noble Lord, Lord Bruce, in a moment, if he will allow me to do so.

Because the draft directive meets a commitment resulting from the fourth directive, exemption for banks and other financial institutions, the Government recognise its rightful place within the Community's Company Law Harmonisation Programme, notwithstanding our continuing concern about the demands imposed by that programme on the resources not only of Government, but also of the business sector and the interested professional bodies, not to mention in passing the time of your Lordships.

The noble Lord, Lord Lever, was I thought rather grudging in suggesting that the Commission and thus, I think, the Select Committee were addressing themselves to the wrong question— "frolicking on the periphery", as the noble Lord rather colourfully described it. However, the fact is that for reasons which the Select Committee explained, the accounts of banks have their place in the Community's agenda for company law. That is not to say that the Commission or, indeed, the supervising authorities in the various member states are not addressing themselves to the much larger questions in the field of banking.

As the Select Committee's report notes, the draft directive is currently under consideration by the European Parliament and by the Economic and Social Committee. I understand that our latest information is that the European Parliament at least is now unlikely to report on the proposal until well into this year. It is possible that the Commission will then consider it desirable to make some amendment to the draft before its consideration by a Council working party commences. The immediate timetable is therefore somewhat uncertain. However, we believe that the Belgian presidency do not at present have any plans for meetings of the Council working party during their tenure, and it seems very likely that negotiations will not now commence before the autumn at the earliest, and possibily even later.

Given this likely course of events, the Government will, of course, not finalise their negotiating objectives until the position is a little clearer, and I am sure that your Lordships would not expect a definitive exposition of the Government's views at this stage. The Select Committee's report, which it is already clear will be an invaluable catalyst to further discussion in this country, quite apart from the valuable debate we have had this evening, will be one of the elements in our consideration of the issues, and it and the evidence will need careful study.

So will the responses to the consultative document published by the Department of Trade in July last year. These responses, a number of which have come in only relatively recently, provide a wide and informed range of opinion both on the major and on the more technical issues. We are grateful for the thought and effort that has gone into these responses, which I believe illustrate the growing realisation that those who wish to influence a Community directive must get in at the beginning, however far ahead final adoption may appear.

Turning now from procedural matters to the substance of the draft directive, I am sure that the Select Committee was right, if I may say so, to concentrate on the major issues of undisclosed reserves and of scope. This is borne out by the debate today which has, to a large degree, concentrated on the question of undisclosed reserves.

On the former, the Select Committee expresses unequivocally the view that banks should not be permitted to maintain undisclosed reserves. We note that this was the general view expressed to the committee by users of accounts, but that certain categories of bank at least felt strongly that undisclosed reserves should be permitted. It is not surprising that the pattern of responses to the department's consultative document is very similar.

As the report points out, the facility for undisclosed reserves has a long history in this country, and the last major review, as far back as the Jenkins Committee in 1962—I think the noble Lord, Lord Plowden, referred to that—concluded that on balance they should be retained. But, given the other changes that have taken place since 1948 in the accounting requirements placed on companies, it is perhaps a little surprising that there should have been so much stability in this particular aspect since that time. It may be that this has always been regarded—except of course by those directly concerned—as a somewhat peripheral element in the general statutory accounting requirements. Be that as it may, we now have to weigh up in earnest the pros and cons of full disclosure by credit institutions.

However, I think that it would be right to emphasise that the outcome of this directive is not a matter for determination by the United Kingdom alone. We have carefully noted the committee's recommendation that the United Kingdom should press strongly in the negotiations for the removal of the elements in the draft directive which would permit the use of undisclosed reserves. However, we also note the very interesting summary in paragraph 8 of the committee's report of the position in other member states, and elsewhere. The fact is that at present the great majority of member states do permit undisclosed reserves, as do a number of important countries elsewhere in the world. It is true, and very material, that undisclosed reserves are not permitted in the United States and Canada. The significance of a change to full disclosure for the institutions concerned in the Community should, however, not be underestimated. I take note of the strong view of the noble Lord, Lord Bruce, about Article 37. I assure the noble Lord that that view, which he is not alone in holding, will be fully taken into account in forming the Government's final conclusions.

As I said earlier, the Government are not in a position at this stage to indicate definitively their negotiating position, and this is as true of their attitude to undisclosed reserves as on other matters. However, what is clear is that the merits of undisclosed reserves will have to be very critically examined in the negotiations. We would agree with the committee that the burden of proof rests with those who believe in the necessity for the retention of undisclosed reserves. The purpose of annual accounts is to provide a record of a company's performance and state of health. The purpose of the efforts to harmonise the law on accounts within the Community is to enhance the comparability of accounts. A facility to retain undisclosed reserves must be regarded as derogating from both these objectives. That is not to say that the arguments for such a derogation should be dismissed, and indeed the Select Committee has set out the arguments put to it with great fairness.

The Government have not yet reached a final view on this question. But, not least because of the Select Committee report, and in view of the considerations to which I have just referred, we are certainly approaching the subject in a critical frame of mind. Notwithstanding that the Companies Acts have for many years provided certain exemptions for banking and discount companies, this policy has not been systematically reviewed for a number of years, and the onus must now be on those, whether in this country or in the Community, who support a provision for undisclosed reserves to justify such a facility in the light of the kind of arguments which your committee has so trenchantly expressed.

A number of noble Lords this evening have put the case for undisclosed reserves, particularly in respect of accepting houses, with considerable force and conviction. We shall of course take all the views expressed in this debate both by the progressives and by the defenders of the status quo—as I think the noble Lord, Lord Roll, put it—into account in deciding our position.

A number of noble Lords have referred to the concept of "true and fair" in this context. Some indicated that a bank could not maintain undisclosed reserves and show a true and fair view. Others denied strongly that the two concepts are incompatible. The noble Lord, Lord Seebohm, was certainly on the first end of that spectrum. Perhaps I should make two comments on this. First, as the noble Lord, Lord Benson, said, it was an important achievement of the United Kingdom negotiators to introduce the concept of "true and fair" into the fourth directive.

I would not seek to explain all the implications of "true and fair" to your Lordships this evening. That might be something for perhaps an accounting seminar, to which the noble Lord, Lord Bruce, would doubtless wish to contribute. What I would say is that the alternative to an overriding concept such as the "true and fair" one is for accounts to be subject to detailed, prescriptive, and perhaps inflexible requirements which allow little, if any, discretion for accounts to reflect the particular circumstances of a particular company.

Secondly, the present law in this country, the eighth schedule, to which reference has been made this evening, makes it clear that accounts which take advantage of the exemptions which enabled undisclosed reserves to be maintained shall not, by virtue of that, be deemed not to show a true and fair view. On the other hand, the law does not say that such accounts do show a true and fair view. In essence, therefore, the matter has been left to the auditors. I believe that in recent years it has become increasingly the practice for auditors to draw attention to the fact that advantage has been taken of the exemptions, and not to report therefore that the hank's accounts show a true and fair view. In short, this is a matter which will need careful consideration in the course of the negotiations.

I have here, in fact, two sets of accounts relating to financial institutions. Both, it happens, to be signed by the same firm of accountants. In one of them they say: In our opinion the statements have been prepared in accordance with the provisions of the Companies Acts 1948 to 1980 applicable to banking companies". And in the other they say: In our opinion the balance sheet of the company gives a true and fair view of the state of affairs at the particular date in question, and complies with the Companies Acts 1948 to 1980, and the consolidated balance sheet"— and so on and so forth. So it is clear that the practice is not identical even within the same firm of accountants.

Apart from the question of principle, the Government will have to consider other important aspects. For example, if undisclosed reserves were to be permitted by the directive, is the form and scale proposed appropriate? Should they be regulated by member states or, as is proposed in the present draft, should it be left to the undertakings themselves whether or not they take advantage? These are sensitive questions, perhaps the most important ones that arise on the directive, and the Government will give full weight to the Select Committee's views before coming to their own conclusion.

Turning now to scope, the committee favours comparability between deposit-takers whatever their legal form but sees no need to extend the scope of the directive to those who grant credit without taking deposits. It also considers that building societies might be brought into the ambit of the directive from the outset and that the directive should provide sufficient flexibility to accommodate the special characteristics of institutions such as discount houses.

In its consultative document of July 1981, the Department of Trade expressed its initial view that the acknowledged purpose of the draft directive—that is to fill the gap left in the fourth directive—would best be met by limiting the scope of this directive to credit institutions that are limited companies since it is only to such entities that the fourth directive applies. Extension of the scope to other kinds of entity, partnerships or incorporated associations for example, would break new ground in the harmonisation of accounts both domestically and so far as the Community's harmonisation programme is concerned and could well give rise to serious legal procedural difficulties in this country since our present arrangements for the filing of accounts are directed at companies.

We have received very mixed views on this matter in response to our consultative document. Indeed, each of the our options exposed in the paper has its advocates, and there is no weight of opinion in favour of one option or another. It has to be said that the full implications of the directive as now drafted are obscure in some respects so far as scope is concerned, and both the Select Committee's report and the responses to the consultative document indicate that there are a number of technical aspects that need further exploration and which the Department of Trade will pursue with the bodies concerned.

The Government noted with interest the reference in paragraph 23 to a possible further draft directive on the accounts of branches of banks. One or two noble Lords have mentioned that this evening. The Government agree with the committee that such a directive would be entirely without value, and we have made this view known to the Commission. In any event, we see little point in work on such a proposal preceding adoption of a directive on the accounts of banks themselves.

The third major issue dealt with by the Select Committee, albeit briefly, is the question whether the directive should provide exemptions from the disclosure of information for institutions covered by the directive which fall below a certain size; the model would perhaps be the exemptions provided in the Fourth Directive for small and medium-sized companies. At present no exemptions are provided in the draft directive. The Select Committee agree with that position for this directive if it is to apply only to deposit-taking institutions. If the scope of the directive goes wider, the committee consider that other institutions should be treated similarly to their counterparts covered by the fourth directive.

Perhaps surprisingly, this was not an aspect which attracted the attention of many of the respondents to the department's Consultative Document. Of those that did address themselves to the matter, there was virtual unanimity against the provision of exemptions for small institutions. Indeed, a number argued that the smaller the institution, the more desirable it was that its financial position should be fully disclosed. We can at least conclude at this stage that there is no widespread demand in this country for such exemptions.

Your Lordship's committee did not pursue in detail the host of technical matters that arise on the draft directive. The Department of Trade has itself received a considerable amount of detailed comment on these aspects, which it is now assimilating, but I consider that the committee's reference to the concern expressed about undue rigidity is very pertinent. There is obviously a tension between the objectives of harmonisation and enhanced comparability, on the one hand, and the practical need in the real world for adequate flexibility, particularly in a directive that aspires to cover a whole range of institutions and activities. But what is important is that at the end of the day the directive should be a practical document which will result in the preparation and publication of meaningful information.

I come to the specific point raised by the noble Lord, Lord Bruce, about the form which the legislation might in due course take. Although implementation of the directive is several years away, I recognise the interest of your Lordships in the matter and the concern expressed that there should be proper parliamentary control. There are of course two general points. The first is the question whether primary or secondary legislation is appropriate in a particular case, and that is a general one which is not confined to company law or Community initiative; no Government today can carry on business without making use of secondary legislation.

Secondly, the European Community Act 1972 makes a general provision for any Community obligation to be implemented by secondary legislation. Certainly not all Community obligations should be dealt with by that route, but it is a fact that the crucial period for debating and modifying a Community project comes before its adoption, not afterwards.

With those general considerations in mind, the Government will no doubt consider which legislative route is appropriate to any particular obligation, when it arises. As your Lordships will recall, the two Companies Bills which we have introduced in the present Parliament have dealt with two significant company law directives, and I do not believe that any Government would carry through what amounts to a fundamental re-writing of a large part of company law other than by Act of Parliament. On the other hand, there are some directives of a technical nature which make relatively insignificant changes to our existing law. In those circumstances, secondary legislation is likely to be appropriate and in such cases your Lordships' House would have an opportunity to express its views when implementing regulations are laid.

As this stage I am afraid it is not possible to come to a view on what will be the most appropriate legislative route for the particular draft directive we are dis- cussing this evening. It is at an early stage of its life and changes may well be made to the draft by the Commission following the observations of the European Parliament and the Economic and Social Committee. Furthermore, significant changes may well be made by the Council of Ministers during what I expect to be fairly lengthy negotiations. As I said, the time to take a decision on the legislative route to implement a particular draft directive is when the obligation arises; that is when the directive is implemented and when we can be certain of the nature of the obligations it creates. At that time we shall of course pay full regard to the views expressed on the matter during the course of this debate.

The Government are grateful to your Lordships' committee not just, as I said earlier, for its invaluable work on this directive and for eliciting such informative evidence; we are also grateful to the committee for recommending its report for debate by this House and thus for enabling the Government to have the benefit of the contributions of great [...]hority that have been made today. I do not believe there is another institution within the Community which could bring so much personal experience and eminence to bear on this subject as your Lordships' House. It will be evident that there is a good deal of further work to be done on this draft proposal, both in this country and in Brussels. I believe the Government can, without undue immodesty, take credit for exposing the issues for public debate at the earliest possible opportunity. The Select Committee's report, and this debate, have also made a major contribution to the clarification of the issues that arise. As I indicated earlier, it now appears that there will be an interval before the negotiations start in Brussels. The Government propose to use that interval profitably by studying the responses to their consultative document, as well as the Select Committee's report, not to mention the important contributions made in your Lordships' debate today

7.47 p.m

Lord Plowden

My Lords, we have had a most interesting debate in which differing views have been expressed forcefully and persuasively. I join with other noble Lords in congratulating the noble Earl, Lord Airlie, and the noble Viscount, Lord Chandos, on their maiden speeches. They put forward somewhat differing views delicately, gently and persuasively and I hope they will not delay in joining us in further debates in this House.

I wish to comment on a remark of the noble Lord, Lord Roll. He and I worked together for many years and very rarely did I disagree with the advice he gave me, or in the discussions we had, but I am bound to say that I did not agree with the view he took tonight. I found, in listening to him most carefully, that he did not put forward any argument as to why the disclosure of reserves would do any harm to the accepting houses or imperil the confidence of their depositors and clients. Further, he and the noble Earl, Lord Limerick, expressed the view that we had not given sufficient consideration to the views of the acceptance houses on the question of undisclosed reserves. If one counts up the columns of evidence, it will be found that out of 23 columns, about 12 relate to the discussion on undisclosed reserves.

Moreover, of the representatives of the British Bankers' Association who attended and gave evidence, two of them were from acceptance houses and one from a clearing bank; one was indeed a partner of the noble Earl, Lord Airlie. The discussions we had concentrated so much on the question of undisclosed reserves that one of the witnesses, a director of an accepting house, asked us to pay more attention to the views of the clearing bankers—at question No. 63 that is set out—and moreover, the acceptance houses submitted to us, after the British Bankers' Association saw us, an additional paper which they asked us to consider, which we considered very carefully; but they asked us not to print it in the report, so we did not do so.

As the noble Lord, Lord Trefgarne, has pointed out, most of the debate has concentrated on the question of undisclosed reserves, but in our report we made a number of other recommendations, and these are summarised in paragraph 29. I was encouraged by what the noble Lord said about the attitude of the Government—that they would be considering this matter.

Of course, the noble Lord pointed out, in relation to this draft directive, that it is not for the United Kingdom alone; the other members of the Community will have to be persuaded, or will have to decide what happens. But I think the noble Lord said that, so far as the United Kingdom is concerned, the Government would be considering this matter, and considering it in such terms—using the phrase that we used—that the burden of proof was on those who wished to retain undisclosed reserves, and not on those who criticised them. I quite understand that it will take some time for the Government to consider all these matters, but I know that the noble Lord will forgive me if at some time later in the year we ask him a Question as to how they are getting on.

On Question, Motion agreed to.