Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1540 - 1547)



  Q1540  Jim Cousins: But in your discussions at the tripartite committee if you did have concerns, you would be expressing them in front of other parties who might themselves be the owners of the institution whose management you have some question about.

  Sir Callum McCarthy: I should make clear that all of these are hypothetical circumstances, but you should assume that we would discharge our responsibilities with the same independence that we adopt towards any institution for which we have responsibilities.

  Q1541  Jim Cousins: One of the issues, looking back over the Northern Rock affair, is the failure to anticipate things. Now I am not myself going over that ground, the Committee has gone over that ground. The issue of nationalisation is not now a theoretical one, it is something that is being actively advocated by a large number of influential people. Are you really telling me that, yet again, we have a failure to anticipate consequences and that there has been no discussion either at the FSA or at the tripartite committee as to how the regulatory system we have for banks would be affected in the event of a bank nationalisation? I find that extraordinary.

  Sir Callum McCarthy: I would say that I do not find it extraordinary. I do not find it extraordinary because at the moment we have got two proposals on the table for private sector solutions and we are concentrating very hard on discharging our responsibilities in relation to that. I am yet to be convinced that were there a nationalised bank what are the real problems that this would present for the tripartite arrangements. If there were significant ones we would deal with them, but I do not think that I am convinced there would be difficult problems.

  Mr Sants: To your point, we are clear—the Chairman has answered the question—what our regulatory responsibilities as the FSA would be for that entity and it would be our role to discharge those in our capacity as an independent agency, so I think we are clear about our regulatory responsibilities, there should not be a misunderstanding about that.

  Q1542  Jim Cousins: The Governor and you, Sir Callum, would look the Chancellor in the eye, if he were to find himself the owner of a bank, and raise criticisms about it?

  Sir Callum McCarthy: If there were a question, for example, of inadequate systems and controls within a nationalised bank over which we had supervisory responsibilities, I would have absolutely no difficulty in doing what you suggest.

  Q1543  Chairman: Sir Callum, a couple of final questions. In 2006 Northern Rock appointed Rosemary Radcliffe, a former partner of PwC, to their audit committee and their auditors last week mentioned that they raised concerns about this but withdrew them following the receipt of what they called an "explicit clearance" from a regulator. Were you the regulator involved and, if not, did you express any views on the matter?

  Sir Callum McCarthy: I think no views were expressed on the matter.

  Mr Sants: I think we were the regulator involved, but I know of no views being expressed on that.

  Sir Callum McCarthy: Could we come back?

  Q1544  Chairman: Definitely. Karin Forseke, a non-executive member of the FSA board, was a CEO of the Swedish investment bank Carnegie until March 2006. The Swedish regulators found that Carnegie's 2005 and 2006 annual reports presented incomplete information and punished the company with the maximum financial penalty, also insisting on multiple board changes. In these circumstances, have you considered whether it is appropriate for her to remain a non-executive member of the FSA board?

  Sir Callum McCarthy: Yes, Chairman, I have considered it very carefully. I discussed the matter extensively with the Swedish financial regulator and took advice on the report and at rather considerable expense had the report, which is only in Swedish, translated into English so we could look at the evidence in detail and formed a view, which I formed after consulting the past and future Deputy Chairman of the FSA, that it was appropriate for Karin Forseke to remain a member.

  Q1545  Chairman: As a Committee, we visited Sweden in the last couple of weeks and we read the regulatory report in English, so it was no problem for us, but it was quite a censure that the regulator gave. In the light of your answers, I think for the public record I would like you to write to us on this the issue in detail as to why you have confidence in her as a non-executive director and the reasons for that.

  Sir Callum McCarthy: I would be delighted to, yes.[2]

  Q1546  Chairman: Last question. Do you think that either you as the regulator or the market have a proper understanding of the size of the tail risk in money or credit markets? I say this in light of the evidence that we have looked at from Paul Ormorod and Bridget Rosewell.

  Sir Callum McCarthy: I think the analysis of tail risks is an extraordinarily difficult issue. By definition you are saying that you expect events which happen very infrequently, that is what you are examining, and anybody who claimed they had a full understanding of the risks associated with tail risks would be open to appearing misleading.

  Mr Sants: I do not think it is possible to have a full understanding of tail risks.

  Q1547  Chairman: We understand that, but what they are saying is a gap between the Bank of England's base rate and the three-month Libor is an indication of unusual conditions in the market and really their conclusion was it should not be assumed that the historical data on this gap follows a normal statistical distribution as many have done. Are you alert to that and, for instance, is there some justification in suggesting that the tails of the distribution of spread between the three-month Libor and the base rate may be fatter than conventional analysis might suggest?

  Sir Callum McCarthy: It is certainly the case that there has been a very substantial divergence between the three-month Libor and the bank rate, that is manifest in the UK, the Eurozone and the United States. It is exacerbated at the moment by the year end pressures, so that is undoubtedly the case.

  Mr Sants: It is also undoubtedly the case with regard to financial markets, as others have said to you, that relying solely on historical statistical analysis as a method of predicting the future via modelling is not a sufficient way to discharge your responsibilities as a board of directors. You do need to take into account the likelihood that the future will not reflect the past and circumstances will not repeat themselves in the way they have in the past. That is why we continue to reiterate the statements we made in the earlier part of the year which are even more appropriate now than they were, that firms need to seek to run full scenario tests, understand the circumstances under which their business models have come under pressure regardless of whether or not that type of modelling looks particularly probable from a tail risk analysis. They should run their businesses to take into account those risks and, as we said earlier, we do not feel that it was the case that all institutions were taking that approach to risk management in the early part of the year. We believe that recent events and supervisory engagement mean that they are much more focused on this point, but it is still a key factor that they need to properly focus on.

  Chairman: On that technical point, could I thank you, Sir Callum and colleagues, and wish you a merry Christmas and a peaceful new year, starting with your reappearance at this Committee shortly thereafter.

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