Examination of Witnesses (Questions 220
TUESDAY 9 OCTOBER 2007
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
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
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
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
Mr Sants: Granite.
Q239 Chairman: It was under Granite?
Mr Sants: Yes.