Select Committee on Treasury Fifth Report

1  Introduction

The run on the Rock

1. At 8.30 pm on the evening of Thursday 13 September 2007 the BBC reported that Northern Rock plc had asked for and received emergency financial support from the Bank of England.[1] The terms of the funding facility were finalised in the early hours of Friday 14 September and announced at 7.00 am that day.[2] That day, long queues began to form outside some of Northern Rock's branches; later, its website collapsed and its phone lines were reported to be jammed.[3] The first bank run in the United Kingdom since Victorian times was underway.[4] In this Report we examine what caused the run on the Rock, the consequences of that run for Northern Rock itself and for wider financial stability, the way the events were handled by public authorities and the lessons to be learned.

The conduct of our inquiry

2. Early in 2007 we identified financial stability as a matter of growing importance meriting greater scrutiny. On 1 February 2007, we took evidence from representatives of HM Treasury, the Financial Services Authority (FSA) and the Bank of England on the operation of the Memorandum of Understanding between them on co-operation in the field of financial stability.[5] In March 2007, we announced our intention to conduct a series of inquiries on the theme of "Transparency in Financial Markets and the Structure of UK plc".[6] We published a Report on Private Equity as part of that thematic approach in July 2007, including consideration of issues of economic risk and financial stability.[7]

3. On 20 September we were due to take evidence from Mervyn King, Governor of the Bank of England, and other members of the Monetary Policy Committee (MPC) of the Bank of England on the MPC's August 2007 Inflation Report.[8] Less than a week before that session, the run on Northern Rock occurred. At that meeting, we decided to start an inquiry on Financial Stability and Transparency, and we subsequently published terms of reference for the inquiry in October 2007.[9] We took oral evidence at nine sessions in total. We took evidence from the following witnesses on two occasions: Rt Hon Alistair Darling MP, Chancellor of the Exchequer, the Governor of the Bank of England and Sir John Gieve, the Bank's Deputy Governor with responsibility for financial stability, and Sir Callum McCarthy, Chairman, and Mr Hector Sants, Chief Executive, of the FSA. We also heard evidence from then members of the Board of Northern Rock plc, from academic experts,[10] from ratings agencies,[11] from a panel of senior investment bankers,[12] from PricewaterhouseCoopers, from a panel of investors,[13] and from Ms Loretta Minghella, Chief Executive of the Financial Services Compensation Scheme. We also received a range of written evidence which is published with this Report.

4. We undertook three visits as part of this inquiry. In late November, we visited Stockholm to discuss lessons of the Swedish banking crisis in the early 1990s. In mid-December, the Chairman and Mr Michael Fallon visited Washington DC, principally for discussions about the Federal deposit protection scheme. A list of relevant meetings during these visits is included in Annexes 1 and 2. In early January, we visited Frankfurt and Brussels for meetings at the European Central Bank (ECB) and the European Commission respectively.

5. We also held informal meetings with Mr Andrew Gracie of Crisis Management Analytics Ltd about stress testing and related issues and with Mr Paul Tucker, Executive Director, Markets, and other Bank of England officials about the Bank of England's money market operations. We are most grateful to all those who assisted us during our visits and in the course of our inquiry more generally, and in particular to Professor Geoffrey Wood of CASS Business School, City University, who acted as a Specialist Adviser.

The role of our inquiry

6. In giving evidence to us on 20 September 2007, the Governor of the Bank of England emphasised the important role that this Committee could play in preventing a repetition of the banking problems that had arisen.[14] This was partly because legislative change was likely to be required and partly because of the value of a cross-party approach.[15] In evidence to us, and subsequently on the floor of the House, the Chancellor of the Exchequer stated that he would await the findings of our inquiry before finalising the Government's proposals.[16] In December, the Governor of the Bank of England confirmed his view that the Government was right to wait for our Report before finalising its proposals.[17] Early in January 2008, the Chancellor of the Exchequer told us that he would give full consideration to our proposals before publishing legislation after Easter and emphasised the importance that he attached to obtaining a consensus on that legislation.[18] We welcome the Government's commitment to taking full account of our Report before making its legislative proposals in response to the run on Northern Rock. We consider it crucial that, insofar as possible, measures in this area are taken forward on a cross-party basis. This Report is being agreed unanimously and we believe that it forms the basis for cross-party agreement on such legislative proposals.

Our two Reports

7. In view of the range of evidence received and the diverse issues considered, we have decided to produce two Reports arising from this inquiry. The current Report relates to the events surrounding the run on Northern Rock and the lessons arising from it, including lessons giving rise to recommendations for early legislative action. The second Report will cover wider issues relating to Financial Stability and Transparency, including an analysis of the causes of the closing of certain markets on 9 August and of the longer term national and international action that might be needed. That second Report will also set out how we will take forward our own continuing work relating to Transparency in Financial Markets.
Box 1: 1866 and all that

The most notorious bank run in British history took place in May 1866 at the time of the collapse of Overend, Gurney & Co. The early 1860s saw a speculative boom, fuelled in part by the banking sector reducing its liquidity ratios.[19] Overend, Gurney & Co. was not a retail bank, but a discount house whose deposits largely came from other banks. In the early 1860s, the company expanded from its core business in well-secured Bills of exchange into riskier investments, such as shipyards and shipping lines, with inadequate collateral.[20] Walter Bagehot observed that the company made losses "in a manner so reckless and so foolish, that one would think a child who had lent money in the City of London would have lent it better".[21] Towards the end of 1865 and in early 1866, there was a severe tightening of monetary policy and several businesses to which the company had lent collapsed.[22] An attempt by the company to stave off bankruptcy by converting from a private partnership to a limited liability company failed to attract sufficient new capital. The share price fell rapidly, encouraging depositors to withdraw funds. On 9 May 1866, after an inspection of the company's books suggesting that it was close to bankruptcy, the Bank of England declined to give support.[23]

The following day, Overend, Gurney & Co. suspended cash payments, sparking "terror and anxiety" so that "a run commenced upon all the banks, the magnitude of which can hardly be conceived". About midday on 10 May, "the tumult became a rout. The doors of the most respectable Banking Houses were besieged … and throngs heaving and tumbling about Lombard Street made the narrow thoroughfare impassable."[24] The Bank of England lent £4 million on that day, and secured the support of William Gladstone, the Chancellor of the Exchequer, for suspension of the Bank Charter Act to enable it to lend more in the days that followed.[25] The run was brought to a conclusion, but, during the three weeks following Overend's demise, as many as ten banks suspended cash payments, and Walter Bagehot criticised the Bank of England for lending "hesitatingly, reluctantly and with misgiving".[26]

Scottish banks had been largely unaffected by the crisis of 1866,[27] but were central to the events of 1878. A severe monetary tightening in the second half of that year contributed to the collapse of the City of Glasgow Bank, which had in any case been engaged in fraudulent activities. Other Scottish banks underwrote its outstanding note issue, but not its deposit balances, and the closing months of 1878 saw a run on a number of British banks. Several banks failed, although the banking sector as a whole responded by strengthening liquidity ratios, and legislation was passed in 1879 which provided for compulsory, independent audit of banks.[28]

The events of late 1878 were described in 2003 as "the last time there was to be a general run on commercial bank deposits in England", and it was a modest run indeed compared to that which followed the collapse of Overend, Gurney & Co.[29] There have been subsequent bank failures, but none caused a run. In 1890, Barings suffered a crisis of liquidity; the Bank of England decided that Barings was still solvent, and agreed to advance liquidity having secured agreement from other banks that they would share any losses.[30] On 5 July 1991, the Bank of Credit and Commerce International (BCCI) was closed, causing substantial losses for many depositors, including local authorities, but this did not cause a run or any systemic problems.[31] On 26 February 1995, Barings became insolvent as a result of "unauthorised dealings" by its chief trader in Singapore, but its closure did not have wider adverse effects for the banking system.[32]

1 Back

2   Qq 580, 1668 Back

3   Qq 345, 678 Back

4   For a discussion of previous bank runs, see Box 1. Back

5   HM Treasury, Bank of England and FSA, Memorandum of Understanding between HM Treasury, the Bank of England and the Financial Services Authority, 22 March, 2006; Treasury Committee, Oral Evidence, Thursday 1 February 2007, Financial Stability, HC (2006-07) 292-i Back

6   Treasury Committee Press Notice No.36, Session 2006-07 Back

7   Treasury Committee, Tenth Report of Session 2006-07, Private equity, HC 567-I, paras 1, 35-66 Back

8   Treasury Committee Press Notice no. 74, Session 2006-07 Back

9   Treasury Committee Press Notices no. 83 and 88, Session 2006-07  Back

10   Professor Willem Buiter, London School of Economics, and Professor Geoffrey Wood, CASS Business School, City University Back

11   Fitch Ratings, Moody's and Standard and Poor's Back

12   Goldman Sachs, Deutsche Bank, UBS and Citigroup Back

13   The National Association of Pension Funds, the Association of British Insurers, the Investment Management Association and Hermes Equity Ownership Service Back

14   Qq 4, 149 Back

15   Qq 19, 58 Back

16   Qq 747, 762; HC Deb, 19 November 2007, col 959 Back

17   Qq 1631, 1640 Back

18   Qq 1751-1752 Back

19   M Collins and M Baker, Commercial Banks and Industrial Finance in England and Wales, 1860-1913 (Oxford, 2003), pp 85-89 Back

20   G Elliott, The Mystery of Overend & Gurney: A Financial Scandal in Victorian London (London, 2006), pp 2-4 Back

21   W Bagehot, Lombard Street: A Description of the Money Market (London, 1873; 1908 edition), p 19 Back

22   Commercial Banks and Industrial Finance in England and Wales, pp 85-86; The Mystery of Overend & Gurney, pp 96-146; W T C King, History of the London Discount Market (London, 1936), pp 245-251 Back

23   The Mystery of Overend & Gurney, pp 158-179 Back

24   History of the London Discount Market, p 243 Back

25   The Mystery of Overend & Gurney, pp 183-184; Lombard Street, p 193 Back

26   Commercial Banks and Industrial Finance in England and Wales, p 87; Q 855; A J Schwartz, "Real and Pseudo-Financial Crises", in F Capie and G E Wood, Financial Crises and the World Banking System (London, 1986), p 17 Back

27   The Mystery of Overend & Gurney, p 189 Back

28   Commercial Banks and Industrial Finance in England and Wales, pp 91-97 Back

29   Ibid., p 80 Back

30   History of the London Discount Market, pp 305-308 Back

31   Treasury and Civil Service Committee, Second Report of Session 1991-92, Banking Supervision and BCCI: The role of local authorities and money brokers, HC 26, paras 1-3; Q 838 Back

32   HC Deb, 27 February 1995, cols 693-694; Treasury Committee, First Report of Session 1996-97, Barings Bank and International Regulation, HC 65-I, paras 5-8; Qq 836-838 Back

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