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Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 220 - 239)



  Q220  Mr Todd: When Michael was asking you about Basle II he perhaps did not ask you a rather blunt question because you, I must admit, implied it was a box-ticking exercise; the normal sort of thing, "We thought that was okay and would not have made any difference anyway because it was a small sum of money." Is that the way you appraise your approach to this? It was delivered actually only shortly before the crisis hit this business and it did give a signal of apparent health. I do not know whether you recognise that, particularly the way the company responded, which was bumping up their dividend. Do you appreciate the linkage between your decisions and market reactions to what a company does?

  Sir Callum McCarthy: Could I explain a little bit about the Basle I to Basle II change, which is to try and have a much greater granularity and a much greater accuracy for the estimate of the capital that individual financial institutions require. I do that because I think the description that you gave of it as a box-ticking exercise is absolutely incorrect. It is a rather detailed analysis but it was concerned with capital and the capital requirements of Northern Rock have remained intact during the whole of this period. So, this is not a capital requirements problem, this has been a liquidity problem and the fact that Hector has said, I believe completely correctly, that the change is immaterial to the problem should not be taken as in any way saying that we treated this in a lightweight way.

  Mr Sants: If I could be clear here, if the issue is whether the CRD or Basle, which, of course, is a European directive and international agreement, is relevant here, then we need to bear in mind that we are talking about a liquidity issue here, not a credit issue, and we actually do agree that the liquidity regime should be modernised. We do not want to in any way not indicate there are some other lessons to be learnt here.

  Q221  Mr Todd: Let me turn to the liquidity issue. You have just sent out liquidity questionnaires to banks and building societies.

  Mr Sants: With due respect, I think that is a misreporting by the press.

  Q222  Mr Todd: Let us get the record straight then.

  Mr Sants: I think the press were a little confused in that particular case. Obviously, from the moment that the market conditions deteriorated, we intensified our liquidity communications with the major institutions. That was being done on a regular basis. I think the press either picked up on the fact that that was one of the weekly reports that we had requested or, and I hesitate—

  Q223  Mr Todd: So you have not changed your practice at all?

  Mr Sants: We have significantly increased our practice from the beginning of August, and they only noticed it when they reported that article and gave the impression that was the first time that we had so done. Or else, I think they may have possibly confused it with a different piece of paper that we had recently sent out to some sub-prime lenders. So I think, to be honest, it was a complete misreporting of the facts.

  Q224  Mr Todd: It sounds as if there was something there actually.

  Mr Sants: With due respect, no.

  Q225  Mr Todd: Obviously you have explained that it was not an entirely novel activity, and I would have been shocked if it were, but the impression one gets is that you have significantly ramped up your activity since August.

  Mr Sants: Yes.

  Q226  Mr Todd: So the point stands that clearly you felt that you had inadequate intelligence on this. You have correctly drawn the distinction between the capital base of the business and liquidity, but the important issue of liquidity was an area where your intelligence was presumably relatively weak before August because otherwise you would not have been significantly improving the catch on it now?

  Mr Sants: No, I think that is not right, is it? What we are trying to do is monitor regular and get a real-time feel in a crisis. You would expect us to respond to a crisis differently than the way we respond to business as usual. I think you would not expect us to be asking for minute to minute, real-time information from our banks in normal business, in usual circumstances. I think you would feel that was over regulation. In the circumstances of a crisis you would expect us to be carefully monitoring their liquidity positions, as we were doing.

  Q227  Mr Todd: But obviously not as carefully as you now are. Mr Sants, I think it would be helpful, bearing in mind the time, if you can produce a paper for us on the distinction between your practice before this crisis and your practice now so we clearly understand your point about the press not understanding quite what you were doing.

  Mr Sants: I would be very happy to do so.

  Chairman: Again, it amuses some of the large banks because they mentioned to me that this questionnaire seemed a bit monotonous. So it is very important, Mr Sants, that we probe that because we will be coming back to these things in the future and no doubt we will be seeing you again sometime.

  Q228  Mr Breed: Briefly, because we have concentrated rather a lot on one side, obviously liquidity and the liabilities, but it has been said by you this morning and, indeed, in the Chancellor's written statement yesterday that Northern Rock had a good quality loan book. There are various tests of that and one of the essential tests would normally be arrears, repossessions and so on. It does seem somewhat strange to many of us that an organisation which has a lending criteria somewhat outlying, reported to be five or six times income and such, even lending up to 125% of the property, apparently has arrears statistics and repossession figures somewhat lower than the industry average, and that does not seem to ordinary, sensible people to be a likely scenario. We keep on saying this wonderful thing about the good quality loan book and such. Have you really looked into the actuality of the statistics within the loan book to satisfy yourself that there was indeed a good quality loan book on an organisation which has lent five to six times income and up to 125% of a property?

  Sir Callum McCarthy: If I look at the assets of Northern Rock, of course we were concerned to look at its record. If I look at, for example, the three month arrears figure, although it has increased slightly over the last year, it is still running at less than half the industry average. Northern Rock has no exposure to the sub-prime market because it laid off all that exposure to another institution. If you take the particular 125% offering, which actually has got some limits within it which have to be recognised, the record of bad debts and arrears on that was also very limited relative to the industry average. The loan to value is not excessive. So, in all those respects, we believe that it is correct to say that the loan book was a good quality loan book.

  Q229  Mr Breed: But it was not a means of the way in which they constructed their lending to individuals in respect of the mortgage and the personal loan, the secured and the unsecured and the way in which the unsecured proportion could actually assist the repayment of the mortgage monthly figure, thus ramping up, on an unsecured basis, the lending to an individual whilst at the same time appearing to, of course, satisfy the arrears statistics on the mortgage itself?

  Mr Sants: The difficulties they have got into, as we have all reflected on, was their difficulty in achieving a securitisation programme, or repaying the mortgage book, or in some way or other sensibly raising funding on those asset base. In addition to us having obviously looked at those assets and, of course, as you would no doubt expect, also the Bank, of course commercial banks were in negotiations with them during this period in respect of their endeavours to do a securitisation or a repo and at no point have we heard from any of those parties any suggestions that the loan book is anything other than Sir Callum has described. So I think there is no suggestion here that the problem is that their loan book is anything other than, generally speaking, a good quality loan book that can, indeed, be turned into rated paper; the problem is with the failure or the reluctance of the market to take any of this rated paper.

  Q230  Mr Breed: But you base that upon the statistics or returns provided to you by the company not in an investigation?

  Mr Sants: No, we have been to see the company and, as I mentioned before, we know the commercial banks that have been looking at that mortgage book.

  Q231  Chairman: You are aware that the Northern Rock funding was carried out through off-balance sheet special purpose vehicles, a lot of that funding?

  Mr Sants: Yes.

  Mr Breed: That is the other side?

  Q232  Chairman: I know it is the other side, but you are aware of that.

  Mr Sants: Indeed we are.

  Q233  Chairman: Was it clear to the FSA that that was just a means of shifting the risk into unregulated entities beyond the view and the scope of the FSA?

  Mr Sants: As Sir Callum has indicated, we need to be here careful that we do not inadvertently stigmatise wholesale funding operations as necessary bad for banks. In order to have a securitisation programme which, once a securitisation is done, creates long-term secure funding, you need a special purpose vehicle which provides the avenue.

  Q234  Chairman: Were you aware it was done through a Channel Island subsidiary?

  Mr Sants: The visibility, the content of the programme was perfectly visible to the FSA.

  Q235  Chairman: So you were aware of that?

  Mr Sants: Yes.

  Q236  Chairman: What was the subsidiary in the Channel Islands?

  Mr Sants: We are fully aware of the content of the special purpose vehicle.

  Q237  Chairman: What was the subsidiary in the Channel Islands it was under? Do you know that?

  Mr Sants: Under. I am sorry?

  Q238  Chairman: The Channel Island subsidiary.

  Mr Sants: Granite.

  Q239  Chairman: It was under Granite?

  Mr Sants: Yes.

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