support operation, the run and the guarantee
The decision in principle on support
119. On Monday 10 September, Northern Rock abandoned
its attempts at securitisation and its pursuit of a "safe
about the Bank of England support option had already taken place
before this time. The idea had been mooted when the then Chairman
of Northern Rock spoke to the Governor of the Bank of England
on 16 August.
Northern Rock envisaged the operation as a "backstop"
facility that would only be drawn down should the other possible
funding avenuesin other words, Northern Rock's own actions
by securitising its debt or Northern Rock obtaining the "safe
haven" of a takeover by a major retail bankprove inaccessible.
It appears that a decision in principle that Northern Rock would
be granted a support facility should neither securitisation or
a takeover prove possible was taken at a meeting between the Chancellor
of the Exchequer, the Chairman of the FSA and the Governor of
Bank of England on Monday 3 September.
The final decision was that of the Chancellor of the Exchequer,
but his decision was taken on the basis of a joint recommendation
of the Governor of the Bank of England and the Chairman of the
120. An insight into the likely basis of the advice
given to the Chancellor of the Exchequer in early September was
provided by the Governor's evidence to us on 20 September. On
that occasion he drew attention to two substantial weaknesses
in the legal framework for dealing with failing banks as it stood
at that time. First, were Northern Rock to be unable to honour
its funding commitments, depositors would not receive their deposits
in full beyond £2,000, with only 90% of funds being reimbursed
between £2,000 and £35,000.
Second, in the event of Northern Rock being declared insolvent
and entering into administration, depositors would find their
funds frozen, with the prospect of a long delay before their deposits
were (even in part) reimbursed.
121. We consider the weaknesses of the existing legal
framework for handling failing banks, and why those weaknesses
were allowed to persist, later in this Report.
At this stage, we are only concerned with the decision that the
Chancellor of the Exchequer faced in early September. He was faced
with the clear weaknesses in the framework for handling failing
banks as it then stood. He was also conscious that, had Northern
Rock been allowed to fail, there was a substantial risk that the
spectacle of depositors unable to access their funds in Northern
Rock would lead depositors with other banks to lose faith in the
banking system as a whole, the so-called "contagion"
The reason that we decided to offer lender of
last resort facilities was because we believed that there was
a wider systemic risk to the financial system. Now, that is the
only consideration and that has always been the case as far as
lender of last resort facilities are concerned, and I believed
there was a serious risk of contagion and, therefore, we offered
I do not agree with
that we should have let the bank go under.
122. The Chancellor of the Exchequer's decision
in the first half of September to make a support facility available
to Northern Rock should the need arise was the right one. Had
he chosen not to do so, there would have been a significant risk
of substantial disadvantage to Northern Rock depositors and a
very real prospect of "contagion", whereby the public
would lose confidence in the security of holdings across the United
Kingdom banking system. In view of the weaknesses of the legal
framework for handling failing banks at that time, the Tripartite
authorities were right to view Northern Rock as posing a systemic
risk. Had any other decision been taken, it is quite possible
that the events that unfolded from mid-September onwards could
have been more damaging to consumers and to the United Kingdom
financial system than those that have actually taken place.
CONSIDERATION OF A COVERT OPERATION
123. When he gave evidence to us on 20 September,
the Governor of the Bank of England emphasised his personal preference
for a covert support operation. Having previously explained why
a weekend takeover was not possiblea matter we considered
earlierhe went on to say:
The second way in which the Bank would have preferred
to do it in years gone by, and did do it in the 1990s, and the
way that I would have wanted to do it on this occasion, is to
have acted covertly as lender of last resort, to have lent to
Northern Rock without immediately publishing that fact, publishing
it after the operation had been over so that you and others could
hold us accountable for the operation itself.
At the same session, he also confirmed that a covert
operation was his "first preference" and that he had
"pressed strongly for the ability to conduct a covert operation",
but had been advised that it was not possible.
Sir Callum McCarthy also told us that a covert operation "would
have had some attractive features", but "was not a practical
The idea of a covert operation was abandoned on Tuesday 11 September,
the day after it became evident that prospects of a private sector
solution had failed and that a support operation would be necessary.
Witnesses identified two factors which acted as obstacles to such
a covert operationthe requirement upon the Board of Northern
Rock to make an announcement to the stock market about their situation
and the practical difficulties associated with the possibility
of a leak of a covert operation.
124. Northern Rock was a public listed company and,
as such, had obligations to disclose relevant information to the
stock market. Its last formal announcement to the stock market
had been made in late July when Northern Rock's mid-year results
were announced. These included an increased dividend and a seemingly
healthy financial position, at least in relation to capital adequacy.
Sir Ian Gibson indicated that the Board was very conscious of
its legal position in relation to disclosure:
14 August onwards
legal advisers, the UK Listing Authority, the FSA, later the Tripartite
[authorities], in terms of what was appropriate to disclose at
what point, either about other party discussions or about discussions
with the Bank of England or about the trading circumstances of
the company, and we are fully satisfied that we did follow the
best advice and follow it to the letter.
Sir Ian went on to say that consideration was given
as to whether on-going discussions with the Bank of England about
the support operation ought to be disclosed:
Once we were in discussions with the Bank of
England, our guidance from all involved, including clearance with
the UK [Listing Authority], was that those discussions be not
made public because there are circumstances, and we have certainly
seen the results of those circumstances, that mean it is not appropriate
in the view of the listing authority or the FSA that certain of
those discussions are taken to the market
125. However, it appears that, at some stage, legal
advice was received that the Board of Northern Rock would have
a duty to disclose a support operation in the context of Northern
Rock's wider financial condition soon after the operation was
embarked upon. The Governor explained this first on 20 September:
It was during this particular crisis with Northern
Rock where I found it hard to believe that a public policy intervention
that was in the interests of everyone in Northern Rock [a covert
operation] could not go ahead because of a legal responsibility
to disclose. There is wording in that [European Union] Market
Abuses Directive which would give you the impression that in a
case of financial distress it would be possible not to disclose
but we had to take legal advice. I would say this occurred in
the period between about 22 August and the date on 9 September
when it became clear that we were discussing seriously doing the
lender of last resort operation and we were advised finally that
it could not be covert.
At times on that occasion, the Governor of the Bank
of England appeared to imply that the legal position arising from
the Market Abuse Directive was clear cut: "the ability to
conduct covert support
is ruled out because of the Market
Later during the same session, he conceded that the relevant wording
in the Directive was "ambiguous".
126. The final decision that a covert operation was
not legally possible was based in part on advice received by the
Board of Northern Rock. Mr Applegarth told us:
We were in the process of taking legal advice
about whether such a facility would have to be covert or overt.
The Board had not actually made that decision but our advisers
were, I think, giving us clear advice that it would have to be
The legal advice that we were getting [was] that
it [the support facility] was most probably announceable.
Sir Callum McCarthy also told us that, "in the
particular circumstances, the Northern Rock Board took the view
that they had to make an announcement".
This view was supported by the Governor of the Bank of England:
Northern Rock were very keen to make a public
statement that they had the facility because their view was that
they did not want the covert operation, they wanted it to be overt
because they believed that the sign of reassurance of having a
facility from the Bank of England would help them and, in fact,
that is what would prevent a retail run in their view.
127. Although legal advice about the duty to disclose
was received by the Board of Northern Rock, both Northern Rock
and the Bank of England indicated that the FSA had legal advice
to the same effect, which was made available to the other Tripartite
authorities. In reporting the legal advice given to the Board
of Northern Rock, Mr Applegarth said that
The FSA told us that their view was the same.
So both our legal advisers and the FSA came to the same guidance
When the Governor of the Bank of England gave evidence
for the second time in December, he also emphasised that the FSA
was the source of the decision that a covert operation was not
The final resolution of whether there could or
could not be a covert operation was reached on the Tuesday before
the facility was given. It was a decision by the FSA, supported
by the Tripartite legal advice, on two grounds, one under the
listing requirement, which the FSA is responsible for, and Northern
Rock's obligations as a listed company and, secondly, under the
Market Abuses Directive, and we were advised by the FSA that under
both it would require Northern Rock, not the Bank, to make a public
statement to the fact that it had the facility
advice was clear
It was the FSA's advice, but it was taken
by the lawyers involved in the Tripartite arrangements. There
were lawyers from all three bodies.
The FSA's oral evidence implied a somewhat more passive
role for the FSA and the legal advice of the Tripartite authorities,
Sir Callum McCarthy stating that "we believed there was no
legal basis for preventing" the Board of Northern Rock making
a public announcement,
and "we saw no reason to disagree with the Board's view that
it was necessary for them to make an announcement".
128. A subsequent written submission from the Tripartite
authorities clarified the relationship between legal advice for
Northern Rock and the legal advice of the FSA:
It is in the first instance for a listed company
to consider its disclosure obligations, in conjunction with its
advisers. Within the framework of the Tripartite arrangements
and the Financial Services and Markets Act 2000 it is the responsibility
of the FSA as the UK Listing Authority to supervise listed companies
in this respect
The question of whether Northern Rock,
as a listed company, was subject to specific obligations to disclose
was an issue for the company itself, and for the FSA as the UK
Listing Authority. It was the view of the FSA that, once the company
had obtained emergency liquidity support, an announcement would
have to be made if the market was not likely to be misled, given
previous statements made by the company. Hence there was no reason
to dissent from the view taken by the directors of the company,
on the basis of their own legal advice, that an announcement should
129. Since we first took evidence from the Governor
of the Bank of England, some evidence has emerged that calls into
question whether the Market Abuse Directive requires disclosure
in the circumstances faced by Northern Rock. Professor Buiter
told us that:
There is nothing in the
Market Abuse Directive
to prevent covert support to banks in trouble. On the day [the
Governor of the Bank of England]
said it, the statement
was contradicted by a spokesman for the Commission, and every
lawyer I have talked to since then says that they have no idea
where that interpretation came from.
130. Article 6 of the Market Abuse Directive states
1. Member States shall ensure that issuers of
financial instruments inform the public as soon as possible of
inside information which directly concerns the said issuers
2. An issuer may under his own responsibility
delay the public disclosure of inside information, as referred
to in paragraph 1, such as not to prejudice his legitimate interest
provided that such omission would not be likely to mislead the
public and provided that the issuer is able to ensure the confidentiality
of that information
131. During our visit to Brussels in early January
2008, we were told by Commission officials that there was no intention
that the Market Abuse Directive should act as a barrier to covert
support operations. Indeed, our attention was drawn to part of
Article 3 of the relevant implementing Directive which we were
told was phrased partly in order to permit appropriate action:
Legitimate interests for delaying public disclosure
For the purposes of applying Article
6(2) of Directive 2003/6/EC, legitimate interests may, in particular,
relate to the following non-exhaustive circumstances
in course, or related elements, where the outcome or normal pattern
of those negotiations would be likely to be affected by public
disclosure. In particular, in the event that the financial viability
of the issuer is in grave and imminent danger, although not within
the scope of the applicable insolvency law, public disclosure
of information may be delayed for a limited period where such
a public disclosure would seriously jeopardise the interest of
existing and potential shareholders by undermining the conclusion
of specific negotiations designed to ensure the long-term financial
recovery of the issuer.
132. The relevant provisions of the Market Abuse
Directive and the implementing Directives have been implemented
in United Kingdom law through changes to the FSA Handbook.
Rule 2.5.1 of the Disclosure and Transparency Rules within that
Handbook transposes Article 6 of the Market Abuse Directive:
An issuer may, under its own responsibility,
delay the public disclosure of inside information, such as not
to prejudice its legitimate interests provided that:
(1) such omission would not be likely to mislead
(2) any person receiving the information owes
the issuer a duty of confidentiality, regardless of whether such
duty is based on law, regulations, articles of association or
(3)the issuer is able to ensure the confidentiality
of that information.
Rule 2.5.2 of the Disclosure and Transparency Rules
provides a commentary relating to the first proviso:
(1) Delaying disclosure of inside information
will not always mislead the public, although a developing situation
should be monitored so that if circumstances change an immediate
disclosure can be made.
(2) Investors understand that some information
must be kept confidential until developments are at a stage when
an announcement can be made without prejudicing the legitimate
interests of the issuer.
Rule 2.5.3 of those Rules provides a word-for-word
transposition of the commentary on negotiations relating to the
financial viability of an issuer contained in Article 3 of the
relevant implementing Directive cited above.
133. Prior to implementation, the Treasury and the
FSA said the following with regard to the above text:
Disclosure of inside information can, however,
be delayed by issuers to protect their legitimate interests (such
as during the course of negotiations), provided that the confidentiality
of the information can be ensured during the delay and provided
that such delay would not be likely to mislead the public.
The Chancellor of the Exchequer noted in oral evidence
that the "provisos" setting out the circumstances when
an announcement could be delayed made the application of the exemption
from disclosure hard to judge, 
and went on to say:
There is some flexibility [under the Market Abuse
Directive] provided you can keep it confidential, and in today's
world that is a big ask maybe, and the second thing is that you
have got to be sure that you are not misleading people. Well,
you have to ask yourself the question: when do you get to the
stage where you might be doing the misleading?
On one view,
there is sufficient flexibility in the Market Abuse Directive
to do that [conduct a covert operation], provided, I think I am
right in saying, that you can be assured it is kept confidential,
but again that is difficult, and also that you are not actually
134. In the context of the legal position regarding
disclosure, the Chancellor of the Exchequer emphasised the importance
of the advice received by the Directors of Northern Rock that
they would need to issue a profit warning or at least make a statement
to the public markets.
The Chancellor indicated that the Market Abuse Directive itself
was not a material factor in his own conclusion that a covert
operation would not be possible.
135. By the time of his second appearance before
the Committee in December, the Governor of the Bank of England
acknowledged that "I gather now that at least on the Market
Abuses Directive there is still a difference of view between some
interpretations in the UK and some in Brussels but also some differences
in interpretation between the original advice we had and the current
advice that is being received".
136. A written submission from the Tripartite authorities
in mid-January 2008 appeared to support the Governor's initial
emphasis on a clear-cut interpretation of the Directive. That
submission described the provisos that we have quoted above relating
to confidentiality and not misleading the market as "two
overriding conditions" and states that, "as the Directive
is currently drafted, neither of these conditions can be waived
The submission also states:
News that a financial institution's financial
position is such that it requires emergency liquidity support
from the Bank of England is capable of constituting inside information
as it is information which could have a significant impact on
the institution's share price. Unless the conditions for delaying
a disclosure are met, the information would in that case need
to be announced to the market as soon as possible.
The view of the FSA, that we have previously cited,
was that, "once the company had obtained emergency liquidity
support, an announcement would have to be made if the market was
not likely to be misled, given previous statements made by the
In other words, the FSA's view as Listing Authority was that the
emergency liquidity support operation could not be covert on the
grounds of the overriding condition relating to misleading the
public, regardless of whether or not the information was capable
of being kept confidential.
137. On the basis of the texts cited in the preceding
paragraphs, we accept that the provisions of the Market Abuse
Directive and the implementing Directive relevant to market disclosure
in the case of Northern Rock in September 2007 were properly transposed
into United Kingdom law. It is evident from the texts of both
the Directive and of the FSA Handbook that any decision to delay
disclosure, even in the case of an issuer that is in grave and
imminent danger, is subject to provisos relating to the need for
the issuer to be satisfied that such a delay would not be likely
to mislead the markets and that the issuer is able to ensure the
confidentiality of that information. The Governor of the Bank
of England received legal advice through the FSA from lawyers
working for the Tripartite authorities indicating that the Market
Abuse Directive was a barrier to a covert operation, even if information
could be kept confidential, and, as such, the Governor was justified
in regarding the legal interpretation of the Market Abuse Directive
shared by the Financial Services Authority and Northern Rock's
legal advisers as a material factor in consideration of a covert
operation, although it was not necessarily the leading factor
in the final decision that a covert operation was not possible.
138. In explaining why a covert operation did not
prove possible, several witnesses indicated that the foremost
considerations in their minds were ones of practicality. Echoing
views expressed by Sir Callum McCarthy,
Mr Sants told us:
We are expressing a view that it seems unlikely
in the overall set of circumstances that prevail in the market-place
today that keeping an operation of this size and complexity covert
for any length of time is realistic, independent of the standing
of the Market Abuse Directive.
Mr Applegarth was of a similar view:
because there were so many people involved, in
practical terms, it [the support operation] would have leaked
I think that is a pretty strong probability.
He also emphasised that the leaking of a covert operation
had the potential to be more damaging than the premature disclosure
of an overt operation.
139. On both the occasions that he gave evidence,
the Chancellor of the Exchequer indicated that he was always sceptical
as to whether a covert operation could remain confidential in
"today's market conditions".
He emphasised the "feverish speculation" which existed
in late August and early September 2007, when, for example, an
acknowledgement by a major clearing bank that it had used the
Bank of England's standing facility had caused a sharp fall in
that company's share price.
He also informed us that he did not seek or take legal advice
because he judged a covert operation impossible. As he summed
up his position, "My belief was that there was every chance
that this was going to leak and I was dead right".
140. The Governor of the Bank of England, in his
second appearance before us, appeared to accept that the practicality
of a covert operation was in doubt. He told us that "I think,
from my conversations with central bankers from around the world,
they are very conscious of this case [the Northern Rock crisis]
and they recognise that, irrespective of what the law says, in
practice now it may be extremely difficult for lender of last
resort operations to be conducted in the covert way that they
were even in the early 1990s".
141. In the circumstances of Northern Rock in
early September 2007, the barriers to a covert support operation
were real. Any large scale support operation for Northern Rock
would have become known to many market participants. In the febrile
and fevered atmosphere of that period, media speculation would
have followed. The leaking of news of a support operation that
was intended to remain covert for a period of time would have
been potentially as damaging as the premature disclosure of an
overt operation. The practical risks of a leak are linked to the
legal difficulties, insofar as covert support operations only
appear to be permitted under the Market Abuse Directive in instances
when the issuer can be assured of confidentiality. We consider
later in this Report whether there are circumstances when a covert
support operation should be considered in future, and what legal
and other changes might be necessary to facilitate such an operation.
142. However we also find it unacceptable that
the possibilities for covert action had not been properly considered
much earlier. Had this issue been clarified, the authorities could
have reacted with more despatch which in itself might make covert
action a more realistic option. We return to the state of readiness
of the authorities and "war gaming" later in this Report.
PREPARATIONS FOR THE ANNOUNCEMENT
143. By Monday 10 September it was evident that a
Bank of England support operation for Northern Rock would be necessary.
On that day, Sir John Gieve spoke for the first time to the then
Chief Executive of Northern Rock about the proposed facility.
By the following day, it was apparent that that operation would
need to be publicly announced.
The succeeding days saw preparations put in place for legal agreement
on the operation and for handling the announcement and its consequences.
The Chancellor of the Exchequer argued that the practical arrangements
for the emergency liquidity operation were undertaken rapidly:
We actually did it quite quickly. As I said before,
it is the directors who are running the bank and they did not
actually come to the Bank of England and say, "Look, we actually
now need facilities" until the week in question, and once
they had agreed to come, there was no problem whatsoever. It was
not like filling out a form for a personal loan or anything like
that. They were able to get the facilities when they wanted them.
144. It was initially decided to announce the support
operation on Monday 17 September.
The Chancellor of the Exchequer implied that this initial timetable
reflected the wishes of Northern Rock itself.
Witnesses from Northern Rock and the FSA confirmed that Northern
Rock's plan was to use the time prior to an announcement on Monday
to increase the bandwidth of Northern Rock's website and to make
other arrangements for handling customers and others affected
by the announcement.
145. The plan to announce the support operation on
Monday 17 September was only abandoned on the afternoon of Thursday
13 September, in circumstances we consider in the next paragraph.
In October, with reference to this initial timetable, the Chancellor
of the Exchequer agreed that "it would have been astonishing
if you could have kept that [the support operation] quiet for
In view of the role that fears of a leak of a support operation
had played in the decision on Tuesday 11 September that a covert
operation was not possible, the Tripartite authorities were unwise
initially to accede to Northern Rock's request for the announcement
of the support operation to be delayed until Monday 17 September.
In the light of subsequent events, it seems evident that the Tripartite
authorities and Northern Rock ought to have strained every sinew
to finalise the support operation and announce it within hours
rather than days of the decision to proceed with the operation.
A swift announcement would have been assisted by early preparation
of such an announcement. In that context, we find it surprising
that high level discussions between the Bank of England and Northern
Rock about the support facility did not take place prior to 10
146. On the afternoon of Thursday 13 September, according
to the Governor of the Bank of England "rumours in the market
started" in relation to the proposed operation.
At 4.00 pm on that day, the Tripartite standing committee met
at deputies level and decided to bring forward the announcement
of the operation to 7.00 am on Friday 14 September.
The Court of the Bank of England met on the evening of Thursday
The terms of the emergency liquidity assistance were finalised
in the early hours of Friday 14 September.
The announcement was made at 7.00 am that morning in the following
The Chancellor of the Exchequer has today authorised
the Bank of England to provide a liquidity support facility to
Northern Rock against appropriate collateral and at an interest
rate premium. This liquidity facility will be available to help
Northern Rock to fund its operations during the current period
of turbulence in financial markets while Northern Rock works to
secure an orderly resolution to its current liquidity problems
The FSA judges that Northern Rock is solvent, exceeds its
regulatory capital requirement and has a good quality loan book.
THE LEAK AND ITS EFFECTS
147. Before the provision of emergency liquidity
assistance by the Bank of England to Northern Rock could be announced
formally, the outlines of the operation were reported by the BBCat
8.30 pm on BBC News 24 and then on other BBC media outlets.
Several witnesses argued that the premature disclosure of the
support operation in this way was instrumental in the run that
followed. Mr Applegarth said that the leak "caused immense
He thought that "it was the announcement of the facility
being leaked that actually was the start of the run".
The Chancellor of the Exchequer characterised the leak as "clearly
Sir Callum McCarthy told us:
It was extremely unfortunate that the information
leaked because it meant that instead of this being put in place
as, 'This is a solvent institution which has a cash flow problem
and the Government is stepping in to make sure that it is saved',
it became a panic measure or a response to something that was
already in the making. Panic was how it was seen.
148. In explaining the impact of the disclosure both
the then Chairman and the then Chief Executive of Northern Rock
contrasted the impact of that disclosure with the likely impact
of a planned announcement the following Monday. Dr Ridley said:
Had the leak not happened and we had been able
to announce on the Monday the facility with the Bank of England
in a measured fashion, with full communication plans in place,
undoubtedly there would have been some concerna lot of
concernto many of our customers but we think it would have
been considerably less than it was in the way that it came about.
Mr Applegarth endorsed this view: "I think the
chairman is right in that the probability of a retail run would
have been lessened had we been able to do the announcement as
we had intended on the Monday".
Witnesses from Northern Rock contrasted the effects of the leaked
information about the emergency lending facility on the evening
of Thursday with the possible effects of a planned announcement
on Monday morning. As we have already seen, the planned announcement
had been brought forward to the Friday morning even before the
BBC reported the planned announcement. In failing either to
make an announcement earlier in the week or to put in place adequate
plans for handling press and public interest in the support operation,
the Tripartite authorities and the Board of Northern Rock ended
up with the worst of both worlds.
THE RUN ON THE ROCK
149. The run on deposits of Northern Rock which took
place between Friday 14 September and Monday 17 September was
the central element in the problems that Northern Rock has faced
The speed and extent of withdrawals meant that the Bank of England's
emergency facility, which had been envisaged as a "backstop",
actually needed to be called upon almost immediately.
The run started on the evening of 13 September, following, in
the Chancellor of the Exchequer's words, "the fairly dramatic
news that a fairly well-known bank had gone to the Bank of England
for help" and the run accelerated the following day.
150. The run gathered momentum in part because of
the difficulties encountered by Northern Rock customers in seeking
to withdraw their money. Mr Applegarth attributed these difficulties
in part to the fact that the support operation had been brought
The probability of a retail run would have been
had we been able to do the announcement as we
had intended on the Monday, to be able to put facilities in place
and also to actually improve our ability to get the money to the
customers. One of the things we had intended to do over that weekend
was to widen the bandwidth on the internet account so you would
not have had so much frustration from our internet customers.
We would have been able to get the money back to customers better.
According to Sir Callum McCarthy, the Internet access
provided by Northern Rock was "inadequate", although
he emphasised that all those seeking to withdraw funds that way
were successful in doing so.
151. While most withdrawals were made through the
Internet, by telephone or by post, the most enduring and damaging
images of the run were those associated with queues outside Northern
Northern Rock did not have a large branch network: it had 72 branches
in total, and only four branches in London.
Many branches had only a couple of counters, because the bank
did not normally conduct much of its retail business over the
of money laundering requirements, large withdrawals could take
up to 15 minutes to be completed.
These factors together explained why it did not take many customers
to seek to withdraw their funds for queues to extend out of the
front door and into the streetand into the public consciousness.
152. The Governor of the Bank of England indicated
that, once the run had started, and in view of the weaknesses
of the legal framework for handling banks in distress, other depositors
were behaving rationally and logically in joining the run by seeking
to take their money out also:
Once the depositors of Northern Rock had heard
the bad news and they suddenly realised that Northern Rock needed
a lender of last resort facilitythis is the problem with
an overt operationonce they had seen that there was bad
news about Northern Rock, and they could not possibly be reasonably
expected to have been sitting at home thinking about the wholesale
funding structure of Northern Rock, once they learned that there
was concern about Northern Rock it is not that surprising that
they thought perhaps it might be safer to take some money out.
Mr Applegarth also had no criticism to make of Northern
I can understand readily the logic of somebody
who has their life savings invested in an institution and who
sees pictures of people queuing outside the door and they go and
join that queue. That is quite a logical reaction.
STOPPING THE RUN
153. The momentum of the run on Northern Rock deposits
once it had begun was caused by two factors. First, depositors
were becoming aware that, were the run to continue, Northern Rock
would eventually cease to be a going concern.
Second, public awareness increased of something of which many
depositors might previously been unawarenamely, that deposits
above £2,000 were not guaranteed in full.
154. In these circumstances, the Governor of the
Bank of England stated that the only way to halt the run was to
provide a Government guarantee of deposits in Northern Rock.
The Chancellor of the Exchequer "became convinced" on
Sunday 16 September that action along these lines was necessary.
The announcement of the guarantee took place during a press conference
after 5.00 pm on Monday 17 September that the Chancellor of the
Exchequer held with US Treasury Secretary Hank Paulson. The Chancellor
of the Exchequer informed the public that:
In the current market circumstances, and because
of the importance I place on maintaining a stable banking system
and public confidence in it, I can announce today that following
discussions with the Governor and the Chairman of the FSA, should
it be necessary, we, with the Bank of England, would put in place
arrangements that would guarantee all the existing deposits in
Northern Rock during the current instability in the financial
markets. This means that people can continue to take their money
out of Northern Rock. But if they choose to leave their money
in Northern Rock, it will be guaranteed safe and secure.
The announcement late on Monday 17 September had
the desired effect. The momentum of the run was halted.
CONSIDERATION OF THE GUARANTEE AND THE TIMING OF
155. During our inquiry, we examined in detail the
questions of when the Government guarantee of Northern Rock deposits
was first considered, whether it should have been announced earlier
and whether preparations of such an announcement could have been
put in hand at an earlier stage.
156. Participants in the discussions surrounding
the liquidity facility to Northern Rock. emphasised the difficulty
that they faced in predicting the effect of its announcement.
Sir John Gieve told us:
We knew when we did that that the announcement
of that would have two effects: a good effect because it would
show they had a new source of finance but a bad effect because
it would send the market a signal that they really needed a new
source of finance. In the event we knew that there was a risk
that that balance would go the wrong way and it did.
The Governor of the Bank of England told us that
he did not view a bank run as "inevitable" on Thursday
13 September, when the date of the announcement of the support
operation was brought forward because of market rumours:
The nature of a bank run is that it is a knife
edge: it might happen, it might not. That is exactly why a bank
run is so difficult to handle.
He emphasised that the provision of the support facility
might have had a reassuring effect on depositors,
and went on to say: "I do not think anyone could have known
with any certainty at all what would have been the consequences
on retail depositors of the announcement".
157. Sir Callum McCarthy supported the view of the
Governor of the Bank of England that the likely effect of the
announcement of liquidity support was not "obvious".
The then Chairman of Northern Rock also emphasised the unexpectedness
of the run:
I think it is worth reflecting that all of us,
both here and in the authorities, were surprised by the degree
to which the announcement of a facility from the Bank of Englandnot
the use of it but the existence of a facilityand the reassurances
that went with it about us being a solvent and profitable business
did not have a sufficiently reassuring effect on customers.
158. In view of the awareness apparent within the
Tripartite authorities and within Northern Rock's Board that a
retail run was one possible consequence of the announcement of
the Bank of England's liquidity support, we asked witnesses from
the Tripartite authorities about the extent to which a Government
guaranteethe device that was used on Monday 17 September
to halt the runhad been the subject of prior consideration.
159. Sir John Gieve implied in his evidence in September
that the possibility of announcing a Government guarantee alongside
announcement of the support facility was at least considered,
and was consciously rejected:
In terms of the crisis, the key question that
underlies your questions is was it worth on Friday announcing
that the Bank was making a facility available or should we have
said at the same time that the Government guaranteed all the deposits?
We did realise there was a risk that, if you like, the shock effect
of an announcement would overwhelm the positive effect of saying
the Bank was standing by with some money. We knew that was a risk
but we thought that it was not an overwhelming risk and it was
worth taking that step.
He reinforced the impression of prior consideration
of the Government guarantee when he next gave evidence:
When we were planning the lender of last resort
support we knew that it might not work and, if it did not, there
would then be a choice between either, in a sense, guaranteeing
all the deposits of the bank or, alternatively, allowing Northern
Rock to go into administration, but we took the view that it was
worth trying a classic lending operation first, because that offered
the chance that Northern Rock would be able to get through the
liquidity difficulties in the short-run and then resume normal
operations after that.
Mr Sants did not appear to attach great importance
to the early discussions on the question of a Government guarantee:
"I think I may have some vague recollection of it being mentioned
by some working group discussion, but that is the extent of it".
160. The Governor of the Bank of England was firmly
of the view that it would have been "irresponsible"
to announce a Government guarantee at the same time that the liquidity
support was announced, commenting that, in such circumstances,
"It would undoubtedly be said: 'Why on earth is this being
John Gieve said that the decision not to offer a Government guarantee
at the same time as announcing the support facility "was
a Tripartite decision in which, I think, all three parties were
161. Once the retail run gathered momentum, the idea
of Government guarantee was given fuller consideration by the
Tripartite standing committee at the level of deputies.
Sir John Gieve indicated the timescale on which he considered
such a guarantee emerged as an issue:
We did realise that offering a limited collateralised
facility was not guaranteed to save Northern Rock. We hoped that
it would restore confidence, and I think that was a reasonable
judgment at the time, and other people commenting on it at the
time thought so too, but I think we did not do enough to reassure
the retail depositors, and that became clear on the Friday.
Sir John had earlier implied that, in the light of
subsequent events, the announcement of a Government guarantee
might have been of benefit on that Friday: "If we had known
it was going to be essential on Monday we might well have offered
it on Friday but that was not certain at that stage".
162. Although, according to Sir John Gieve, a unanimous
"decision" had been reached by the Tripartite authorities
not to announce a Government guarantee at the same time as the
the Governor of the Bank of England and the Chancellor of the
Exchequer both told us that they did not discuss the Government
guarantee prior to Sunday 16 September, when discussions took
place between those two and the Chairman of the FSA.
A decision was taken on that day by the Chancellor of the Exchequer
to give the Government guarantee. He told us that consideration
of the precise terms of the guarantee meant that an announcement
was not possible before the markets opened on Monday 17 September,
and so the final announcement was made after markets closed on
163. The Chancellor of the Exchequer argued in October
that a decision would not have been possible earlier than the
I frankly do not think that the issue of a guarantee
or the extent of the cover under the depositors' scheme was an
issue on Friday. It suddenly became an issue over the weekend
The guarantee itself was not an issue on the Friday morning
when those queues started to build up.
The Chancellor of the Exchequer reiterated this view
in January, and
went further in questioning whether an earlier announcement of
the Government guarantee would have had the same effect as did
its subsequent announcement:
things were such on the Friday that I suspect
that, no matter what I stood up and said in relation to a guarantee,
you would still have had the queueing problem because what you
had was a dramatic announcement, and this is something that has
changed in the last 20 years with 24-hour news, and the queues
started to form and the situation just got worse and worse and
worse, and I think it was not actually until the Saturday that
people started talking about guarantees.
164. Professor Buiter took a rather different view:
If [the Tripartite authorities] were not quite
convinced that the public would believe themand in these
days you cannot be sure of thatthen the immediate creation
of a deposit insurance scheme that actually works and is credible
would have been desirable. To wait three days was again an unnecessary
165. We accept that the consequences of an announcement
of the Bank of England's support operation for Northern Rock were
unpredictable. There was a reasonable prospect that the announcement
would have reassured depositors rather than having the opposite
effect, particularly prior to the premature disclosure of the
operation. However, after the premature disclosure of the support,
and against the background of the market reaction to Barclays
use of lending a fortnight earlier, it seems surprising that the
issues were not urgently revisited. It is unacceptable, that the
terms of the guarantee to depositors had not been agreed in advance
in order to allow a timely announcement in the event of an adverse
reaction to the Bank of England support facility.
166. The Tripartite authorities were conscious
during the planning of the support operation that announcement
of that operation might have an adverse effect. In light of this,
we regard it as a serious error of judgement that the Tripartite
authorities at deputies level failed to plan in advance for the
announcement of a Government guarantee and failed to raise some
of the issues surrounding such a guarantee with the principals
prior to Sunday 16 September. We are also concerned that it did
not prove possible to announce the guarantee that was decided
upon that day before the markets opened the following day. The
cumulative effect of these failures was to delay the guarantee
until the evening of the fourth day after the run started and
thus to make the run on the deposits of Northern Rock more prolonged,
and more damaging to the health of the company, than might otherwise
have been the case.