Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 400 - 419)



  Q400  Mr Fallon: You do not now regret that decision?

  Mr Applegarth: It was a very sound decision. It had no relation to what hit us. What hit us was the freezing of global liquid markets.

  Q401  Mr Fallon: Your business model, Dr Ridley, was described by the FSA Chairman as "extreme". You were borrowing 75% of your funding from the capital markets; you failed to insure against any increase in the inter-bank rate; you failed to hedge the period between taking out a mortgage and its completion, because presumably you thought rates had peaked. This was not banking; this was a heavily leveraged bet on interest rates was it not?

  Dr Ridley: I think it is worth clarifying what the funding side of our balance sheet was. It is true that we had a smaller retail deposit book than many other institutions, although there are many like us overseas. As the Chairman of the FSA also said, in terms of the short and medium term wholesale funding, as a ratio of our balance sheet assets, we were not an outlier. Most of our wholesale funding was in the form of securitised bonds and covered bonds, which are long-term funding. The average maturity is longer than the average life of a mortgage on our books.

  Q402  Mr Fallon: But why did you not see the risk of capital markets closing to you? Why did you not insure against the danger of illiquidity?

  Dr Ridley: We saw that there was a risk of tightening in the credit markets and we prepared for that. What we did not expect was that there would be no flight to quality in that process. In other words, we expected that as markets became tighter and as pricing for risk changed that low-risk prime UK mortgages (and we have below half the industry average of arrears on our mortgage book) and such a low-risk book would remain easier to fund than sub-prime mortgages elsewhere. That is why we were very determined to keep the credit quality of our book high, in order to be able to attract funding.

  Q403  Mr Fallon: But a very high proportion of your funding was dependent on the capital market, a much higher proportion than other lenders?

  Dr Ridley: We were dependent on, as I said, the wholesale markets but also the securitisation market and the covered bond market. We deliberately diversified our funding platform so that we would have those three different types of funding and indeed a diversified programme within the wholesale funding, and geographically we had programmes in the United States, Europe, the Far East, Canada and Australia. That was deliberately so that if one market closed we would still have access to others. The idea that all markets would close simultaneously was unforeseen by any major authority.

  Q404  Mr Fallon: But a heavily leveraged bet on the movement of interest rates and on capital markets remaining open for an over-exposed model like this seems to me a fairly basic banking error, is it not?

  Dr Ridley: We were subject to a completely unpredicted and unpredictable closing of the world credit markets. Our model was entirely transparent to the market and to the regulator. It was discussed regularly with both and it was not at the time seen as running a particularly high risk in terms of liquidity.

  Q405  Mr Fallon: But it was your duty as Chairman and as a Board to ensure that your bank was liquid.

  Dr Ridley: We reviewed liquidity regularly and we reviewed our policy on liquidity and our policy on funding regularly.

  Q406  Mr Fallon: But you were wrong?

  Dr Ridley: We were hit by an unexpected and unpredictable concatenation of events.

  Q407  Mr Fallon: So you are the Chairman of a bank that ran out of money and that caused the first bank run in this country for 150 years; you have had to borrow billions of pounds of public money from the Bank of England; you have damaged the good name of British banking; why are you still clinging to office?

  Dr Ridley: I would like to say that what has happened has been extremely distressing to us, as it has been to our other stakeholders, shareholders, employees and creditors. In view of what has happened I am extremely keen to try and turn the situation round and develop a stable future for Northern Rock. I am working night and day to achieve that. I serve at the behest of the Board and if they think that they can do better by asking for my resignation, it will be available to them.

  Q408  Mr Fallon: But this is a humiliation. Has none of the Board any sense of honour? Has nobody offered to resign?

  Dr Ridley: I would like at this point perhaps to suggest that Sir Ian Gibson answers that question.

  Q409  Chairman: No, you answer it Dr Ridley, that is what you are here for.

  Dr Ridley: Yes indeed, I was going to say I will give a quick answer to it first. I have made it clear to the Senior Independent Director, as is his role, that my resignation is available to him as soon as he thinks it is in the interests of the company, its shareholders, creditors, employees and other stakeholders that I go.

  Q410  Chairman: You did say that you discussed the risk on this issue with the Chief Executive on 10 August; that is correct?

  Dr Ridley: Correct.

  Q411  Chairman: And that this was unpredicted. You have said that two or three times to Mr Fallon.

  Dr Ridley: Yes.

  Q412  Chairman: But were you aware of the Bank of England's April 2007 Report on Financial Stability and were you aware of the Financial Risk Outlook from the FSA in January 2007?

  Dr Ridley: Yes, I was aware of both of those reports.

  Q413  Chairman: Did it influence Board decisions?

  Dr Ridley: It did influence Board decisions.

  Q414  Chairman: What did you do from January to April?

  Dr Ridley: We did a number of things. We prepared to sell some of our asset books, as you will know because of announcements we made at the half year—our commercial loan book and our unsecured loan book and—

  Q415  Chairman: I would suggest to you, Dr Ridley, you failed because if you look at the Bank of England statement it is very clear, in late April it says that: "Recent developments in the US sub-prime mortgage market have highlighted how credit risk assessment can be impaired in these markets and how participants can be hit by sharp reductions in market liquidity. It is important therefore that firms stress test and we take them into account ... " That was in April so what you did from April to 10 August seemed to have no effect whatsoever on the position that you found yourself in, so you did not take corrective action that was successful?

  Dr Ridley: As you say, that report was about the pricing for credit risk in the markets as well as liquidity and we ensured that our funding was—

  Q416  Chairman: But Dr Ridley, let us forget about the words here, this talks specifically about reductions in market liquidity. You are telling us that this was unpredicted, but this was informed to you by the Bank of England in April, you were warned, and from April to 10 August you did not have a successful strategy, is that correct, or otherwise you would not have found yourself in this position?

  Dr Ridley: We were not warned of a complete freezing of all global liquidity markets.

  Q417  Chairman: Let me just read it to you again. It says here " ... how participants can be hit by sharp reductions in market liquidity". If that is not a red alert warning I do not know what is a red alert warning.

  Dr Ridley: There were sharp reductions in liquidity after 9/11 in 2001. That lasted for a matter of days. Our model was extremely robust in those conditions. What was not expected was that all global markets would shut down and remain shut down for as long as they have.

  Q418  Chairman: So really what you are saying to us is that the corrective action you took from April, if there was corrective action, was not sufficient to avert this crisis?

  Dr Ridley: The corrective action we took from April was designed for a tightening of the credit markets and a tightening of liquidity in those markets; it was not designed for a complete shutdown of the global markets.

  Q419  Chairman: It said "sharp reductions in market liquidity". In other words, it is a real warning and you did not seem to take up what that meant and therefore found yourselves in this humiliating position on 10 August. That is really the answer to the Committee.

  Dr Ridley: We were in constant dialogue with the FSA.

  Chairman: We will go on to that later on. The main point is made there. Colin?

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