Examination of Witnesses (Questions 1500
TUESDAY 11 DECEMBER 2007
Q1500 Mr Fallon: Sir Callum, if Northern
Rock cannot find the funding it needs to finance its operations
without nearly £29 billion worth of support from the taxpayer,
how do you still describe it as solvent?
Sir Callum McCarthy: Because we
have looked at the assets it has and the demands on those assets
and believe that those assets meet those demands. The amount that
has come from the taxpayer is secured against the assets of Northern
Q1501 Mr Fallon: But if it is not
able to finance its future liquidity, how can you regard it as
Sir Callum McCarthy: Because there
is a distinction between liquidity and solvency.
Mr Sants: We are clear that it
would not meet its thresholds conditions if it were not for the
availability of the finance from the Bank of England.
Q1502 Mr Fallon: But you still think
it is solvent?
Mr Sants: Yes. In clear accounting
terminology, threshold conditions is regulatory terminology and
we have answered the question.
Q1503 Mr Fallon: Yes. I think you
have also explained to us exactly what has been happening. You
have said there are regulatory lessons to be learned here and
you are going to publish a discussion paper on liquidity. Is that
Sir Callum McCarthy: No, there
are two quite different things and let me explain what they are.
One is a paper on liquidity as a general set of issues and, as
Hector said, we plan to publish a discussion paper on that before
the year end. The second and quite different aspect is that we
have undertaken to do a review of the way in which the FSA discharged
its responsibilities in relation to Northern Rock during the period
up until August and we have undertaken to do that and publish
the results of that in March and that is not a discussion paper,
it is a quite forensic investigation.
Q1504 Mr Fallon: Will that include
the possibility of somebody else supervising liquidity?
Sir Callum McCarthy: No, this
is to do with the question of how the FSA discharged the responsibilities
it had up until August 2007.
Q1505 Mr Fallon: I thought we were
pretty clear now that you did not discharge your responsibilities.
We have had the worst banking crisis for 140 years. Somebody failed.
Sir Callum McCarthy: I repeat,
we are looking at the lessons that we are going to learn.
Mr Sants: We have already said
quite clearly that we think the supervisory process with regard
to Northern Rock in the period prior to July should have addressed
the liquidity issues through more aggressive engagement around
the question of stress testing and ensuring that the board, whose
primary responsibility is ultimately to run the institution, fully
understood its business model and its limit to its business model
and the risks it was running. We would agree with you that process
did not take place, so the purpose of the review will be to ask
the questions as to why that did not take place and what lessons
should be learned from that. That is about our application of
our regulatory regime as it then was. There is then a second question
as to whether or not the regulatory regime should be modified
which will be looked at through the combination of the liquidity
discussion paper and, of course, if there are any issues relating
to the tripartite review, that will be handled through the tripartite
review. We are in no way not acknowledging the fact that our supervisory
engagement with Northern Rock prior to July should have looked
into these scenarios and it would appear on the reading of the
file to date not to have done so.
Q1506 Mr Fallon: If you were charged
with supervising banks, including their liquidity, and you failed,
is not one of the answers to return that supervisory duty to where
it once was, which is to the bank?
Mr Sants: I think we need to look
at a couple of points here and they will come out in the review.
There is a question as to whether or not the overall regulatory
proposition is in some way flawed and in addition whether the
narrow engagement of that group of supervisors with that institution
not properly discharged. It would be wrong to prejudge the conclusion
of these various reviews, but my preliminary thoughts would suggest
that the approach we were taking in terms of emphasising stress
testing in principles-based regulation was right. I do not think
that events here undermine the basic regulatory philosophy of
principles-based regulation, the crux of which is about asking
management to take responsibility for the outcomes and consequences
of their decisions and you could well argue here that is something
the board should have been doing more rigorously than it was.
I do not think the philosophy of regulation is undermined here,
there may well be questions, I think there are questions, as I
have just indicated, about the particular engagement with this
particular company. As to the question of whether or not it would
have made any difference if administratively those supervisors
had reported to the bank rather than to the FSASir Callum
may wish to commentI do not think there is any evidence
at all if the reporting line of that supervisory department had
been moved that would have made any difference to the set of circumstances
which transpired prior to July, nor would it have made any difference
to the information being passed over to the relevant part of the
bank with regard to monetary operations during the course of August
Sir Callum McCarthy: Could I just
add one point, which is I think that the idea of transferring
banking supervision separately from insurance and security supervision
is an idea that has severe disadvantages.
Q1507 Mr Fallon: It is a pretty severe
disadvantage with the background and all the damage we have seen
to British banking as a result. You seem to be simply defending
your empire. The supervision of liquidity was done perfectly well
by the Bank of England until you started it in 1997.
Sir Callum McCarthy: People can
have different views on the ability of different supervisory regimes
historically. I would point out that if you look at the problems
that the events have caused, they have caused severe problems
in Germany, where banking supervision is shared between BaFin
and the Bundesbank, so the idea that making bank supervision the
responsibility of the Central Bank is the answer to these is not
necessarily supported by the facts.
Q1508 Mr Fallon: You think you are
still the best people to supervise banking liquidity?
Sir Callum McCarthy: I believe
that it is impossible to take the question of banking liquidity
from overall supervision. There are questions, as Hector has absolutely
indicated, about whether we did that sufficiently well, but I
do not believe you can take bank liquidity supervision from other
Mr Sants: Also you have to ask
the question, what particular benefit do you think would accrue
from aligning a supervisory group with a money markets management
group; a central banking liquidity function? There is no particular
evidence that the issue with regard to Northern Rock would have
in any way been changed by that alignment. I think you do have
to ask the counter-factual question what is it you think would
have been brought to this issue that was not brought to the issue
as a result of making that organisational change.
Q1509 Mr Breed: Could I return to
your view on the solvency of Northern Rock. I think you said that
there is a difference between solvency and liquidity. Of course,
one of the tests of solvency is all to do with liquidity and,
indeed, the vast majority of businesses that go bust go bust because
they have not got cash, not because they have not got assets,
so liquidity is a fundamental of solvency. That test is that a
business can meet its obligations within the normal course of
its business and therefore looking forward, including in Northern
Rock's case, of course, the repayment of £25 to 29 billionwhatever
it isof taxpayer's money, and I understand that is in place
until February, do you, therefore, believe at this moment in time
that Northern Rock is solvent on the basis that it can meet all
its obligations within the normal course of its business, including
that taxpayer's loan to it?
Sir Callum McCarthy: The answer
is yes. We would not deem it solvent unless we believed it could
do that. The fact that it is getting liquidity from the Government
is undoubtedly the case and without that liquidity the bank would
Q1510 Mr Breed: It is totally dependent
upon the Treasury contribution which lasts until February according
to the Chancellor. By February, when the taxpayer may expect to
have all its money back which would be in the normal course of
its current business, you expect that to happen which is an assessment
therefore of its solvency today?
Sir Callum McCarthy: No, I do
not think we are necessarily saying that we believe the taxpayer
will have all the money which has been advanced returned by February
because I think if you look at the Chancellor's statement he said
February or the time at which other events have been reached.
It is clear that the Treasury, in discussions with the bidders,
has been prepared to discuss timetables for repayment which go
beyond that. All that is in the public domain, I am saying nothing
Q1511 Mr Breed: You consider that
sufficient to consider that Northern Rock remains solvent?
Sir Callum McCarthy: We do believe
that Northern Rock remains solvent.
Q1512 Mr Breed: Could I ask finally
then, when is Northern Rock's next trading statement to be published?
Mr Sants: The next trading statement
would come with the final results.
Q1513 Mr Breed: Is there not one
due in the middle of December?
Mr Sants: That would be its pre-close
and then it would have to make a full statement by the spring.
Q1514 Mr Breed: We are now 11 December,
so within the next few days you would expect Northern Rock to
produce an interim trading statement?
Mr Sants: Coming back to the quoted
company point you have just made, I think it is clear to investors
that without the support provided by the Bank of England at the
current time then Northern Rock would not be able to continue
in its current form. There has to be a presumption, as Callum
has already laid out, that support would remain in place unless
an alternative mechanism can be put in place, to justify continuing
the meeting of the threshold and conditions, and that analysis
is correct. In a narrow sense we are clearly dependent on that
funding stream to continue to make the assertions we have made
and that is absolutely right and any statement by the company
will have to reflect that.
Q1515 Mr Breed: Just to repeat, you
are expecting the company to make its interim trading figures
available by the middle of this month?
Mr Sants: It would make a pre-close
statement and then a statement after the end of the year.
Q1516 Mr Breed: You are expecting
that to happen?
Mr Sants: In order to fulfil its
listing conditions it will have to so do.
Q1517 Mr Breed: If it does not, then
its listing might be in jeopardy?
Mr Sants: Its listing could be
Q1518 Mr Dunne: With hindsight, should
the lender of last resort facility have been extended to Lloyds
TSB in order to have allowed a private sector solution?
Sir Callum McCarthy: I think it
is very difficult to form a judgment on that because, as I think
I said last time I was before this Committee, it was not quite
as cut and dried as I think it has been suggested that there was
a complete proposal on the table. It was the case that it was
made clear slightly later than that that the facility which had
been offered to Northern Rock would be offered to other bidders,
ie they could take advantage of it, but it is a difficult set
of circumstances to take a view on even in hindsight.
Q1519 Mr Dunne: You just explained
that you do not believe it would be appropriate for liquidity
supervision to be separated from regulatory supervision and the
regulatory supervision restored to the bank. Do you think there
is an alternative scenario in which the liquidity supervision
should be brought into the FSA so it is brought under a common
Sir Callum McCarthy: No. There
is a question about whether the only route providing finance should
be via the Bank of England or whether the Government should have
other agencies that it could use. I think that is something which
is a possible route. I should make clear that I am not arguing
for the FSA to have a very large balance sheet. That is the last
thing I want.
Mr Sants: We obviously have a
mandate to facilitate private sector solutions and, as was demonstrated
by the retail bank point you just made, you could argue that is
a difficult mandate to discharge when the FSA has no locus with
regard to providing funding with regard to institutional specific
situations. That is a question that could be reasonably considered
but, as the Chairman indicates, there are different ways that
mechanism could be considered.