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“We have had many discussions with the Commission”—[ Official Report, 6 March 2008; Vol. 472, c. 1896.]
I find that particularly interesting. I shall come to the role of the European Commission.
Before we rush into a new regulatory regime, we urgently need to have a look at what has been going on in this institution, which we own, in the past two and a half weeks. As I mentioned during the Second Reading of the Banking (Special Provisions) Bill, I worked on a trading floor for eight years in the 1990s. Bank regulation is not my specialist field, but I know rather a lot about banking malpractice in respect of risk control, risk management and related issues and about the effect it can have on the markets. What I have seen in Northern Rock since 22 February has been an institution whose behaviour, even since nationalisation, has carried on being reckless and unsustainable. That is very serious given that we, the people, now own it.
Let me start with the foreign subsidiaries. [Interruption.] A couple of hon. Members are looking at me as if to ask, “What are those foreign subsidiaries?” I mentioned the Financial Times earlier. On 23 February, the day following nationalisation, its editorial said that the European Commission would not intervene. It added:
“Northern Rock also has the advantage of operating exclusively in the UK.
The Commission is more likely to give a government a free hand when the only economy being distorted is its own.”
The Financial Times certainly thought that Northern Rock was exclusively a UK business.
I shall start by considering the Danish subsidiary. Its website, available in Danish and English, mentions “swilling interest” next to a picture of a large, bloated pig—an interesting way of marketing products in Denmark. The Danish subsidiary shows that Northern Rock is being reckless with UK taxpayers’ money. The bank is both subsidising and guaranteeing above-market savers’ rates to 10,000 Danish depositors—10,000 and counting, very rapidly. In the week after nationalisation, the website welcomed visitors to Northern Rock Denmark, saying that it was open for
“business as usual”. Under the heading “Temporary Public Ownership: What It Means For You”, it stated:
“Your savings with Northern Rock continue to be safe and secure, protected by the UK government guarantee arrangements”.
Why are the UK Government both guaranteeing and subsidising above-market interest rates to savers in Denmark? For one year, the UK Government will give 4.09 per cent. The Copenhagen inter-bank offered rate, or CIBOR, is currently about 4(5)/8 per cent., so why are the UK Government paying Danish savers 5 per cent. through Northern Rock’s Danish subsidiary? The website of Northern Rock’s Irish subsidiary also mentions “business as usual”. It gives a fixed rate for euros of 5 per cent.—staggeringly high, considering that the euro LIBOR is currently at 4.25 per cent.
Let us turn to Northern Rock Guernsey, the offshore aspect of the bank. That subsidiary also offers an interesting set of products. Its website states:
“Investing offshore is the perfect solution for expatriates, foreign nationals or UK residents wishing to take advantage of tax planning opportunities”.
So a UK taxpayer-owned bank is enticing UK taxpayers to avoid paying UK tax. That is all at our expense. The website says:
“Northern Rock’s operations in Guernsey remain open for business as usual”.
What rates does that subsidiary offer? Offshore in Guernsey, someone can buy a Northern Rock bond that will yield 6.75 per cent. for a year; UK gilts currently pay 3.86 per cent.—one gets almost 300 basis points more for sticking money, at the UK Government’s risk, in Guernsey than for keeping it in the UK. The same is true for money invested over three years: one can get 6.4 per cent. from Northern Rock Guernsey, compared to a gilt yield over the same period of 3.83 per cent. Staggeringly, a UK Government-owned bank is enticing UK taxpayers to invest offshore to avoid tax in this country.
Finally, let us look at what is going on in our home market. There are extraordinary Northern Rock products that not only pay a very above-market interest rate, but have extraordinary conditions extremely favourable to the saver. I point hon. Members to the fixed-rate access bond issue 4. If someone invests a minimum of £1, they will get from that 6 per cent. for one year, effective from 4 March. Similar products from Barclays offer only 5 per cent. with a minimum of £500 and no access to the money during the year. Alliance & Leicester will also pay 5 per cent. on its fixed-rate bonds for one year, but early withdrawal costs 180 days’—half a year’s—interest. That offer has a £1,000 minimum. Alliance & Leicester, of course, has been in the news quite a bit recently for possibly being under pressure in the market for reasons similar to Northern Rock’s. Yet the Northern Rock product offers a 6 per cent. interest rate—far higher than that offered by Alliance & Leicester or Barclays. Not only that, the Northern Rock product has this important clause:
“Withdrawals can be made without any notice or charges”.
That is what is called a putable deposit. If interest rates rose, savers could easily pull their money out and stick it in a higher-yielding account, which would become available in an environment of rising interest rates. That is an incredibly useful option for the depositor.
Why is Northern Rock, not only through its foreign subsidiaries but in this country, offering incredibly high, above-market interest rates? We need to consider those issues before we start discussing changing the regulatory regime. We need to look at what has been going on in the past two and half weeks; some staggering things have been happening.
In the past, the focus has been on Northern Rock’s reckless lending, but the bank has also been borrowing recklessly. As we know, Britain has the lowest savings rate of anywhere in the EU, and Northern Rock has been forced to go to countries such as Denmark and Ireland, and offshore, to hoover up savings from countries with higher savings rates.
What can we do to seek reform? We need to consider risk management at Northern Rock. We know nothing about what controls and risk management measures are in place at this new bank that we have taken on. It is no use our waiting for the business plan, because the risk is here right now. We could be exposed to any number of risks—systemic risk, event risk, the risk from rogue traders—through today’s Northern Rock. Who knows what risk management there is in place at the moment?
Since I left banking in 1997, there has been huge growth in risk management, which is now a major part of most of our financial institutions. In my day, there were three or four risk management people out in the back, next to the legal compliance people and others with what in those days were called “peripheral functions”. Now, however, risk management is right at the centre. Unfortunately, we know nothing about the risk management of this new institution. There was clearly a failure in the risk management of Northern Rock in the summer of 2007, and before, when we saw LIBOR rising and the risk of the drying up of liquidity in the inter-bank market. The possibility of that happening should have been foreseen in Northern Rock’s risk management structure and policy. There is no reason to believe that that has changed one bit since 22 February; I rather suspect that the same individuals are in charge of it today as were there three weeks ago.
How is Northern Rock managing its currency risk? I have just talked about its foreign subsidiaries. How is it managing the risk as regards having to repay those Danish savers in Danish krone in a year’s time? Similarly, with the Irish savers, what kind of currency risk management is being undertaken in relation to the euro? What is its interest rate risk management strategy? It is offering a large number of fixed rate savings products, yet most of its mortgage lending is variable, as is most of its wholesale funding—if that is happening, as I suspect it now is.
What is the political risk? It is by no stretch of the imagination impossible that there could be political risk in a state-owned bank; indeed, it happens all the time. Bankgesellschaft Berlin, a German financial institution, got into severe difficulties only five years ago because of inappropriate lending due to political influence. We heard on Second Reading the extraordinary statement by the Chief Secretary to the Treasury that one of the reasons for the speed of the nationalisation of Northern Rock and the urgency behind taking over this £50 billion-odd mortgage portfolio was that we were at the “bottom of the market”. I do not know which market she was referring to—the housing market, the mortgage
market or the interest rate market—but she was taking a massive punt on whatever market it was, and she offered no evidence to back up her decision.
What kind of scrutiny are we going to give Northern Rock in this House? Last week, I tabled a set of questions to ask exactly how we are going to study this £110 billion business that we now own. Will there be a Question Time? If, as we did earlier, we have a 10-minute Question Time on the Olympic games, which has a budget of only £9 billion, should we not have a separate Question Time on Northern Rock, which is a £110 billion business? With the honourable exception of my hon. Friends at Question Time last Thursday, there has been woefully little parliamentary scrutiny of Northern Rock since nationalisation.
My professional experience in banking predates the tripartite regime, so I cannot comment on how effective it is. I have found time to read the Treasury Committee’s report—possibly the first time that I have read a Select Committee report not produced by one of the two Committees I sit on. Like other Members on both sides of the House, notably my hon. Friend the Member for Sevenoaks (Mr. Fallon), I urge caution against over-hasty and over-heavy regulation in reaction to one event. I have seen some of the major financial scandals and failures of the past 20 years, including in the 1990s. I was there during the Hammersmith and Fulham council swaps scandal. In the early ’90s, the Belgian Ministry of Finance lost an enormous amount of money betting on convergence of European interest rates. Then there were the cases of Orange county, the US army facilities management fund and Barings bank. There are not necessarily common features to all those disasters. To some extent, there always will be financial failures. It is our duty as a Parliament to create an oversight structure that seeks to prevent them and to prepare for the consequences, but we have to balance that with a duty to ensure that business is not impeded or encumbered.
We need to act cautiously in changing the regulatory system, but we must act urgently to consider the situation that we now face and to ensure that proper risk management controls are in place at this new Government Department called Northern Rock bank. In other words, we need to think about banking regulatory reform, but the more urgent and important issue is what our arrangements are for the oversight of Northern Rock, which is continuing many of the practices that were in place before nationalisation in an often dangerous and reckless manner.
7.4 pm
Mr. Philip Dunne (Ludlow) (Con): I am pleased to be able to contribute to the tail end of this debate.
The Treasury Committee report is a fine example of a Select Committee having undertaken relevant, topical and timely work, and it is the only independent investigation into affairs surrounding the run on the Rock that has been published so far. I congratulate the Chairman and other members of the Committee, on which I sit, on conducting the hearings that we did and producing a unanimous report. As has been said by Members on both sides of the House, it has captured the imagination of policy makers and commentators as being of value. It is a shame that the Government have not yet grasped some of our recommendations, and I hope that the Financial Secretary will pick up on some of them.
I should like to touch on some of the lessons from the past for Northern Rock before looking forward. The hon. Member for Leeds, East (Mr. Mudie) referred to the tulip bubble and to the American sovereign debt crisis, and my hon. Friend the Member for Hammersmith and Fulham (Mr. Hands) mentioned problems closer to home—at least, closer to his constituency. Financial institutions do go bust. Periodically, there is a herd mentality in financial markets. That is within human nature, and it is not possible to regulate against it. As a consequence, one arrives at extremes, on the way up and on the way down, in any financial market. We would be ill advised to think that one set of banking reforms can call a halt to that process.
The last mortgage bank in this country to fail was National Mortgage Bank in 1992. Although it was much smaller than Northern Rock, there are many parallels. Not least, it was owned by a quoted company, National Home Loans; it relied on wholesale funding, mostly foreign banks; and its business model was not robust when working capital became scarce. In that case, the then deputy governor was able to deploy his famous eyebrows to nominate Barclays to put together a syndicate of 26 banks to provide the required funding, which was covertly guaranteed by the Bank of England. Eddie George, for it was he, did so to protect the reputation of British banking among foreign banks, which were the entities due to lose out from the crisis. Unfortunately, the parallels in the conduct of the Northern Rock case have not enhanced the reputation of regulators or of the Government. Last week, the Chairman of the Select Committee and I attended a debate in the City about whether the case has affected the City’s reputation. The commentators present were more or less united in the view that the City survives these periodic crises, but the reputation of the regulators and, by extension, that of the Government, suffer. I think that that is regrettably the case.
The role of the banking regulators should not be to protect individual banks from the folly of their conduct, but to limit damage in the event of a failure leading to a systemic problem infecting other financial institutions. When the tripartite arrangements were set up 10 years ago, the focus was very much on giving the Bank of England, through the Monetary Policy Committee, the power to set interest rates and to remove that from the political process. Much less attention was given to the regulatory regime for supervision that was put in place at the same time. There was talk of having a new paradigm, with no prospect of a major bank getting into difficulty. As a consequence, as we discovered through the Select Committee inquiries, no stress test was undertaken, when the system was set up or since, on a major bank—that is, one of the top dozen—getting into financial difficulty. That is a fundamental failing of the regime that was set up 10 years ago, from which we need to learn a lesson.
There are some specific lessons to take from the Northern Rock experience. Although we say in our report that there was systemic risk, there were conflicting views at the time when the crisis was unfolding. Who knows how history will look at this with the benefit of hindsight, but people may take a different view from those of us on the front line.
At that time, during August, the Governor of the Bank of England initially appeared to think that there was not a systemic risk, as he was resting on the moral hazard argument that we touched on earlier. The Chancellor, perhaps concerned about the political ramifications, thought that there was moral hazard, but it took him a long time to recognise that, and he stepped in only when the queues were snaking round from the Northern Rock branch front doors. The Financial Services Authority seemed to think that there was a problem, but was not in a position to force the sort of quick decision making needed to get a grip on the crisis.
There were four distinct phases to the crisis that I should like briefly to mention. It is instructive to identify what went wrong in order to decide what needs to be put right. First, in the year leading up to 9 August, various signals were issued by market commentators, and by the Bank of England in January and the FSA in April, that reliance for funding on credit markets internationally was of concern, particularly given the emerging developments in the US sub-prime mortgage sector. Those warnings were not acted upon by the board of Northern Rock, which failed to put in place stand-by lines of credit in the event that its securitisation programmes could not be rolled over.
The bank’s business model, in terms of growing its market share, was clearly reckless, as has been touched on by the hon. Member for Twickenham (Dr. Cable). At a time when house prices in the UK were hitting record highs, this bank was extending its market share dramatically; in the first half of 2007, it captured 19 per cent. of new mortgage advances, compared with its overall market share of 8 per cent.—the former is some 2.3 times higher. At the same time, other major mortgage lenders, such as Nationwide, were reducing their new business exposure. If the regulators did pick that up, they failed to persuade the board to do anything to moderate Northern Rock’s rate of expansion.
The second phase covered the period from 9 August, when the credit crisis struck and closed down the securitisation markets, until 10 September, the date on which the Chancellor finally declined the offer of a lender of last resort facility to Lloyds TSB. Lloyds TSB had indicated that it would be prepared to make an offer should such a facility be available, but only in those circumstances. During that month-long period, the lack of experience of handling a stricken bank in a crisis was exposed at the Bank of England, where, famously, no one was specifically in charge; at the FSA, which consistently advised the Chancellor that Northern Rock was solvent; and at the Treasury, where a new ministerial team had only just been appointed with no one aside from the Chancellor having any prior experience in the Department, and with no senior officials with experience of a previous banking crisis. Advice to the Chancellor on whether a covert operation could be undertaken was confused, with the Bank of England convinced that the market abuse directive prevented covert activities, despite subsequent denials by the European Central Bank and the European Union commissioner, and the evidence of facilities provided to continental banks in a similar situation.
The third phase was a short one, lasting from Monday 10 September to Monday 17 September. That was the period in which critical decisions, or a lack of timely decision making, actively contributed to the run on the
bank. Once the Lloyds TSB offer was finally terminated, the Chancellor and his advisers should have acted far more rapidly to get a grip on the developing crisis. Specifically, they should have confirmed the deposit guarantee at the same time as announcing the lender of last resort facility. It was that lack of action on deposits that led to the queues around Northern Rock branches.
The final phase lasted from the announcement of Government support on 17 September, which was extended on 9 October, until final nationalisation on 22 February, more than five months later. That delay speaks volumes about the lack of experience in the Treasury in handling such crises. Every previous banking crisis has been handled as rapidly as possible, from Johnson Matthey to Barings, or the National Home Loans crisis to which I referred earlier. Those were all handled within a week—sometimes over a weekend. The failure to find a credible private sector buyer should have been apparent when the remaining bidders in December were clearly insubstantial and not credible.
Now the bank has been nationalised, one or two issues need to be addressed. The business plan referred to by my hon. Friend the Member for Hammersmith and Fulham (Mr. Hands) is clearly critical, and the Government have agreed, somewhat reluctantly, that it will be published once it has been finalised by Mr. Sandler. The plan is critical to Northern Rock’s relationship with its funding entity Granite, and to the quality of loans—the asset base that the FSA has consistently said is of high quality. The hon. Member for Twickenham has said that it may not be so sound.
Granite has not been nationalised, but its securitisation issues are backed by Northern Rock mortgages. Northern Rock is obliged to top up that security package if mortgage repayments or redemptions exceed the rate of maturity of the securitisation issues. We learned that, from the September period until nationalisation, no additional mortgages have been provided to Granite by Northern Rock. That can last for a while, but at some stage—I would argue that it will be when the two-year interest rate fixed terms expire at around January of next year—unless very attractive rates are offered, mortgages will be redeemed at what may be a more rapid rate than hitherto.
If Granite’s security package declines and Northern Rock cannot refresh the mortgages that it provides for that underlying security, an accelerated amortisation will be triggered and Granite will be compelled to liquidate at whatever price it can get for its remaining assets. At that point, Granite’s structure will implode, Northern Rock will suffer losses on its 16 per cent. share of the mortgages in Granite, and the taxpayer will lose substantial sums—substantially more than we have been led to believe by the Chancellor. He says that, with business as usual, there will be no loss. The expression “business as usual” is critical, and I shall return to that point.
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