Chapter 9 Banking Services in the United Kingdom: The Law and Practice Report
- Robert Effros
- Published Date:
- June 1994
The objective of the United Kingdom Treasury and the Bank of England in establishing the Committee of Inspection was that we should produce a full and coherent review of the law relating to banking mechanisms and practices, taking into account technological and other developments. This task was daunting in prospect and proved to be formidable in its execution. I led the Committee, joined by Liliana Archibald, a working member of Lloyd’s of London, former official of the European Community and expert on international insurance and trade policy issues, and G. W. Taylor, who had just then retired as Chairman and Chief Executive of the Midland Bank.
We published a report in February of 1989.1 It is quite a formidable piece of work. We made 83 recommendations, 57 addressed to the Government and requiring Government action in the form of legislation and 26 addressed to banks—nearly all of these related to the formation and adoption of standards of banking practice.
By way of focusing, I will speak about our report in light of the Government’s response, which came out in March 1990 in a White Paper.2 I will concentrate on the areas where the Government has deviated from or has not accepted our recommendations.
We had to look at the mechanisms of banking—the traditional paper-based systems of banking. We recognized that while electronic banking and electronic means of transmission of money were increasingly supplanting checks, checks would continue, for the foreseeable future, to be a very important element in any payment system. One of our recommendations was directed at the problem of the stolen check. There have been some unfortunate episodes in the United Kingdom. We recommended that there should be a bank payment order that would be a nontransferable, nonnegotiable check, which would deal with the type of payment for which most checks are made, namely, a simple payment from A to B with no need to negotiate. The bank payment order would in fact be an order that could be collected only on behalf of the payee by a bank and through a bank.
The Treasury and the bankers in the United Kingdom did not consider this the correct solution. They took the view that to introduce a new form of “check” might result in even greater confusion in the public mind about the use of checks. As a result, they opted to deal with the problem of a stolen check by giving legislative recognition to the account payee marking on a check with a consequential duty on the collecting bank to establish the right of the person who has lodged it with the bank. Now, technical bankers will tell you that this is not a crossing because it is not an instruction to the paying bank; it is an instruction to the collecting bank. However that may be, in the whole matter of crossing of checks, it is clear, as we say in our report, that they neither said what they meant nor meant what they said. We held that there is a strong case for clarifying the law on this, and the Treasury accepted that; but they did not accept our idea of a bank payment order, preferring the account fee system. It is a matter for debate whether this is a preferable solution.
The Government accepted our recommendations for legislation relating to bills of exchange that will permit them to be denominated in units of account, like the European currency unit (ECU). They also agreed to our recommendation enabling bills of exchange to be transacted in de-materialized form through screen-based and other systems. They accepted the need for a change in the law so far as checks are concerned to enable check processing truncation, which greatly reduces the flow of paper and lessens the time and labor involved in checks physically returning from the collecting bank to the paying bank.
One decision that has troubled bankers and their lawyers in the United Kingdom is the Tai Hing judgment.3 This was a Hong Kong case, referred on appeal to the Privy Council, where it was clear that an unauthorized payment had been made by a bank in circumstances where there had been clear and established negligence on the part of a customer who had not taken steps to check the bank account and as a result had not realized that money was being stolen from it. The court said that in an action for debt of this kind, seeking recovery of the sum, contributory negligence could not be pleaded. The banks maintained that this put some undue duty on them, and they suggested, and we accepted, that contributory negligence could be pleaded by way of defense.
The Government, while accepting that recommendation, made it subject to a qualification. This is an interesting example of a problem in this field, namely, that banking law is not self-standing. It interacts with and draws upon whole areas of general law like the law of contract, the law of insolvency, and the law of security. It includes a whole raft of issues, where, while the banking element in them is the principal user of the law, the principles extend well beyond the law of banking. In response to the Tai Hing judgment, the Government said that the Law Commission of England was considering contributory negligence as a defense in contract and had published a constitutional paper on this. In view of this, it would be premature for the Government to propose revisions of the laws affecting banks to allow the defense to use contributory negligence when a much wider revision might be necessary. So the Government deferred its decision as to how this should be done. The Government’s response to our legislative proposal was minimalist and muted: it was clear that the Government had problems in finding parliamentary time for measures that did not have great political mileage.
With respect to electronic funds transfer (EFT), the Government generally accepted that the approach should be by way of code provisions and standards of banking practice rather than inflexible rules of law. We did suggest that there might be a case for legislation in regard to disputed transactions through automated teller machines. There had been a great range of disputes over these transactions; customers were left with a sense of grievance that the odds were stacked against them in trying to prove that the payment with which they had been debited had been done other than by the use of their card and their personal identification (pin) number. We were trying to avoid the winner-take-all/loser-lose-all approach of the existing law. The Government, however, did not accept our recommendation, saying that the law as it stood was fairly reasonable and that the customer was given a reasonable chance to prove the case.
A more macro-legal aspect of EFT involves the elusive concept of completion of payments. We recommended that there should be statutory rules to define when payment is completed. We saw these rules as providing more certainty about the legal consequences of a transfer of funds, particularly one effected by electronic means, in the event of a bank failure.
The Government rejected our proposals, concluding that it would be premature and even dangerous to adopt our definition. The Government agreed, however, that it was an important issue currently exercising bankers and others around the world, and undertook to review the need for legislation in the light of the various domestic and international initiatives in this area. Specialist groups working on this aspect include a working group drafting a model law on international trade transfers and a major study on payment netting schemes and cost-bartered payment systems being conducted by major central banks and the Bank for International Settlements.
As I said, completion of payment is an elusive concept, and we were perhaps tentative about our proposed rules, in case there were overriding operational difficulties that we had missed. We suggested that the Bank of England convene a working party to consider the operational implications. But our proposals at least constitute a major contribution to the search within the United Kingdom and internationally for rules that will find general acceptance.
The specter that haunts central bankers is that of default by a member of a payment clearing system. While clarifying the law on completion of payment will not forestall a crisis resulting from a default, it could mitigate this by providing a more certain legal basis on which immediate and long-term decisions could be taken to resolve the crisis.
In dealing with our own central bank we gained the impression that clearing failure was almost a taboo subject. By talking about it one might cause it to happen by undermining the confidence on which clearing systems are based. The security of such systems must be based on the prudential supervision arrangements for its members; in the United Kingdom, these are enshrined in the Banking Act of 1987. That security rests also on the central bank as the lender of last resort. Now, the law has little or nothing to contribute to this security. But in related matters and in other financial markets, principally the securities markets operated by the London Stock Exchange, the law has recently been called in under provisions of the Companies Act of 1989 not yet brought into force.4 These provisions are directed at improving the set-off and the priority in insolvency available in respect of settlement debts. No such provisions are proposed in regard to bank payment clearing systems.
We looked closely at what electronic funds transfer and the general depersonalization of the banker-customer relationship had done to that relationship. We found that there should be a reassertion of the best standards of banking practice and that there should be clear statement of the basis of standards and practices. These could best be achieved by ensuring that the contract or series of contracts, and the use of facilities (like check guarantee cards, cash cards, and debit cards, which are still to come, as far as the United Kingdom is concerned) were based on separate, distinct, written, and explicit and detailed contracts. It is important that these contracts must not only be fair, but be known to be fair, with both of the parties clear as to the duties each owes to the other, and how the arrangements between them will operate. The law and the practice of banking should be characterized by fairness and transparency—essential elements in the banker-customer relationship.
One aspect of that relationship caused us special concern—the obligation of confidentiality that the bank has traditionally owed to its customer. But that obligation has exceptions, including compulsion of law, duty to the public to disclose, interest of the bank to require disclosure, and disclosure made by the expressed or implied consent of the customer.
The compulsion-of-law exception, however, has substantially eroded this obligation of confidentiality. We identified in the United Kingdom some 20 statutes that override the banker’s duty of confidentiality, of which the latest are related to drug trafficking and the prevention of terrorism. While we do not question that these statutory interventions in customer confidentiality are, in each individual case, justified by the public interest, nevertheless cumulatively they amount to a formidable burden on bankers because of the uncertainty as to the precise nature of the obligations imposed by law. They constitute a serious inroad into the principle of customer confidentiality, conceived at the time of the Tournier decision5 of 1924, and clearly an inroad that will continue to grow.
Not surprisingly, the Government did not accept our view on the erosion of bank confidentiality, maintaining that weighing any need for legislation was done “after the most careful consideration of all the implications.” These are measures, the Government said, that would not apply to the vast majority of customers; in all such legislation the effect on the normal confidential relationship between banker and customer is taken fully into account; there are areas, however, in which public policy will override the need to preserve that confidentiality.
Clearly there is a case for balance. The fact that this erosion may be justified on the grounds of general public interest makes it more important than ever that the other two exemptions (in the interest of the bank and with the consent of the customer) are clearly defined and clearly circumscribed. The Government accepted that the code of banking practice should make customers aware of the protections the law affords them and of the limited exceptions to it. The Government would have gone along with our recommendations, insofar as the confidentiality obligation would restrict the right of the bank to use confidential information for marketing purposes, particularly in the marketing of credit. And in fact that report recommendation was recently cited in the Chancellor’s Budget Statement of the United Kingdom, in which he hoped that banking institutions would review their policy about the indiscriminate marketing of credit.
The question of consent or lack of consent has direct regard to credit reference agencies. No one disputes that black information—information about default—should be made available. The debate is whether credit information should be made available to credit reference agencies. This is a subject of keen debate within the United Kingdom between the credit reference agencies (anxious to produce databases for the creditworthiness of their customers and, perhaps, takers of credit) and the customers (who do not wish to have information about themselves disclosed). The banks are in an ambivalent position here because, while they would like to have the information for credit assessment purposes, they worry about what it does to the relationship with their customers, who know that this information is being made available to other bodies.
The Government’s approach was to say that both in marketing and in relation to credit reference agencies, the customer should be given the opportunity to object. Otherwise, consent would be implied and the bank would be free to disclose.
The Government referred to a code of banking practice as a central recommendation. We saw our objectives as being best achieved, particularly in the EFT area, not so much by detailed, statutory prescription, but by voluntary agreement by banks of the need to maintain and develop high standards of banking practice. We asked that the banks make a collective response to our recommendations by formulating collectively a code of banking practice that all banks would observe. The Government accepted that central recommendation and has at the instance of the Bank of England set up a committee to oversee this participation by the banks.
In putting forward our recommendation about a code of banking practice, we were conscious of the need for independent assessment of its contents and its observance. In the United Kingdom, the obvious body to do this was the Office of Fair Trading, which has a statutory duty to support the establishment, in the interests of consumers, of codes of practice by providers of goods and services. It is, however, fair to describe the office’s approach as exclusively concerned with consumer protection.
Considering the special nature of the banker-customer relationship, we decided that another form of oversight was required. We were particularly interested in the function of the Bank of England, which in concert with the Building Society’s Commission, exercises the statutory role of supervision in relation to building societies—in the United Kingdom increasingly important providers of banking services. They are similar in origin and function to the savings and loan organizations in the United States. The Bank evinced no great enthusiasm for this extended consumer protection duty, which would be similar to that assumed in the United States by the Federal Reserve Board under the Electronic Funds Transfer Act. The Bank saw its expanded role as conflicting with and likely to diminish its authority in relation to its primary functions as a prudential supervisor.
We could not regard these objections as convincing. We saw this as a natural extension of the Bank’s publicly perceived role as protector of the integrity of the banking system. This link is well established in other central banks and is consistent with their commitment to secure high standards of conduct from banks within their jurisdiction. The Bank of England would be by far the most acceptable body to assume this task.
One particular feature of law and practice in U.K. retail consumer banking is the twin ombudsman schemes for resolving complaints. We have the banking ombudsman scheme, which is voluntary, and the Building Society’s scheme, which is statutory in the sense that every building society has to belong to an ombudsman scheme and that scheme must meet criteria laid down by the Building Society’s Commission.
We found merit in putting the now-voluntary bank scheme on a statutory basis, although this would have had the effect (for constitutional reasons having to do with the right of access to the courts) that awards against the bank could not be mandatory. The Government rejected this suggestion, holding that the two schemes worked perfectly well and that the argument that a statutory scheme would ensure 100 percent coverage was not significant because according to the last ombudsman’s report, the voluntary bank ombudsman scheme has already achieved about 99 percent of coverage. The big exception so far as the United Kingdom is concerned are the so-called ethnic banks, whose customers are principally immigrants to the United Kingdom.
What is our general impression of the Government response? We are pleased that the Government has welcomed the code of banking practice. We are pleased to see the setting up of the London Committee. We are disappointed that in some matters where we saw legislation as necessary, the Government has not accepted our views. We are disappointed to find that the prospect of legislation is remote. The White Paper displays the ominous words “due course” and “subject to the pressures of the parliamentary timetable.” It will be a pity if legislation is not put in place with some degree of urgency.
It will be a pity if financial services law has to respond to a scandal or an outrage. If action is taken promptly on the accepted recommendations and if we can maintain and increase confidence among the banks, government regulatory bodies, and the banking industry’s customers, a practical and generally accepted code can support transparency, embody fairness, and expedite good practices.