Examination of Witnesses (Questions 1560
TUESDAY 18 DECEMBER 2007
KNIGHT CBE AND
Q1560 Mr Fallon: But it is not true
to say that the American scheme simply operates for the very,
very small banks. Continental Illinois which failed was £40
billion, about half the size of Northern Rock, and that was 17
years ago, so it is not true to say that it is small banks. Your
evidence to us says that you want to stick with this post funding
Ms Knight: Correct.
Q1561 Mr Fallon: Why not put the
money upfront so everybody can see it is there and have a system
where they can get their money back within a few days?
Ms Knight: Putting money upfront
is not the only way of making sure that you can get your money
back in a few days. If there is a requirement on the industry
to pay there is a requirement on the industry to pay. It seems
rather difficult to see why one should have some large sum of
money just hanging around waiting when actually the issue is not
one of is there money to pay out in a difficult circumstance;
it is how quickly can a deposition access their money and what
rules changes and what legislation changes are required in order
for that to come about. If I may say, one of the main concerns
which I think comes out from the memorandum which we submitted
to the Treasury Select Committee is this: we need to be looking
with considerable attention at prevention, and that is where we
believe the whole issue lies; on the preventative side. We think
that the Deposit Protection Scheme as it is currently formulated100%
to £35,000 with a requirement by the industry to pay quicklyis
a workable model. The question that arises is how does it get
from the FSCS to the individual deposit takers, and that is an
area where, as I say, rules and legislation may be required.
Q1562 Mr Fallon: But what the Governor
said was required was a scheme that did not mean that people had
to wait more than a year to get their money out.
Ms Knight: We would entirely agree.
Q1563 Mr Fallon: Are you not dragging
your feet on this?
Ms Knight: No, we have put forward
some proposals, as you know. We entirely agree that a scheme that
requires a year to pay out is not good enough. As Adrian Coles
has just said, where the scheme has been used has been with failed
credit unions, there the payout is quick, and indeed has been
getting quicker. If one is looking at large numbers of individuals,
there are systemic issues and there is panic hanging around there
as well. I do not think that one should just say that it is the
responsibility of an independent or quasi independent scheme to
address that situation.
Q1564 Chairman: Last week, Mr Fallon
and I were talking to your equivalent, the American Bankers Association,
in Washington and they were very clear that an upfront funded
scheme was essential for the confidence in the system in the first
place and, secondly, that when a situation arises where payout
has to be made, it is probably not the best time economically
so you have a fund there that is available. That was their unequivocal
view to us.
Mr Coles: Could I add a point
there. I think the crucial difference between the British scheme
and the American scheme is not the upfront funding; the crucial
difference is that the FDIC is backed by the full faith and credit
of the US Government, and I think that is what gives the confidence
to depositors in the United States.
Q1565 Chairman: No, no, no, but they
were very clear on this upfront funding.
Mr Coles: I know that is a difference
but this is another important difference.
Chairman: You are missing the point.
They were very, very clear on that and they were saying why not
get the money in the fat years so that when the lean years come
there is no problem getting money out of people? That was the
issue. I just put that as public evidence. Nick?
Q1566 Nick Ainger: The Financial
Services Authority in their Financial Risk Outlook in January
and the Bank of England in their Financial Stability Report in
April both gave clear warnings of problems of weakened credit
risk assessment and impaired market liquidity. Why did the banks
not listen to those warnings?
Ms Knight: The banks did.
Q1567 Nick Ainger: What action did
Ms Knight: As far as the banks
themselves individually are concerned, they did, as I am informed,
take full notice of the points that were made to them and the
issues that were raised. Clearly we have one bank that may have
taken a different view and I know that you have had a discussion
with them. I think also, though, the one thing that neither authority
nor indeed the industry, wherever it was in the world, expected
was the way in which the housing problems of the US unfolded as
rapidly as they did and as widespread as they did. Nevertheless,
I think one of the comforts that we can take in the UK is not
only do we have a strong banking industry but they do heed the
documents, the consultations, and the other communication that
are issued from our various authorities.
Q1568 Nick Ainger: So everything
in the garden is rosy, there is no problem? Surely our experience
from August onwards is that there have been serious problems and
warnings were not heeded?
Ms Knight: I do not know why you
say that. Quite clearly there are some very difficult market situations
taking place, but you cannot necessarily cure a market situation
that has arisen nor can you do anything other than handle something
well as it arises. We have well-capitalised banks, they are handling
the situation that has arisen, but what you cannot expect them
to do is suddenly manage to rectify a problem that has arisen
in America. What can be expected them is to look at their credit
assessment and look at how they are handling their own affairs,
and I think that is something that we have seen.
Mr Coles: Can I offer an observation
from the building society point of view there. On the day the
Financial Risk Outlook was published by the FSA, we sent out a
circular to our members strongly advising them to read the FRO.
We gave them full details of the relevant pages for building societies,
the relevant developments in the mortgage and savings market that
would be most important for building societies to read, and our
evidence is that building societies read that carefully and were
fully expecting a slowdown in the housing market this year. They
were not expecting the closedown of markets in August but they
were expecting a slowdown and we encouraged them to read the relevant
Q1569 Nick Ainger: Can I follow on
from that and ask you if Northern Rock had still been a building
society, would it have experienced what it experienced this summer?
Mr Coles: If Northern Rock had
still been a building society it would not have been able, by
law, to fund itself 75% from the wholesale markets. A building
society can fund itself to a maximum of 50% in the wholesale markets
under the Building Societies Act 1986 and, typically, building
societies fund themselves 70% retail and 30% wholesale. Had Northern
Rock stayed a building society, it may or may not have been a
successful institution but it would not have come to the sticky
end that it appears to have come to in the way that it has.
Q1570 Nick Ainger: Ms Knight, do
you think perhaps there is a lesson here to be learnt for the
banks in that if they adopted the same requirements that the building
societies have, that would actually give greater protection and
security and stability?
Ms Knight: The Northern Rock had
a particular business model, as you know. If you are looking at
the banking industry generally of course, it is much broader based
in what it does in terms of its operation, how it funds itself
and its various activities. If you have any institution of any
sort which has a very narrow focus, in terms of both its business
model in what it does and indeed how it funds itself, then clearly
it is far more hostage to fortune than would otherwise be the
case. I think one of the issues as well in all this, though, comes
back to your earlier point about the FSA's communications on risk,
and that is that the challenge process that the regulators undertake
with various institutions in respect of risk and exposure. This
is something that certainly we believe warrants looking at further.
Clearly the FSA did have an engagement earlier this year with
the Northern Rock in terms of stress-testing and risk and so forth,
and this highlights an area that is something, as far as the industry
is concerned, requires clarification. We want to see proper stability
in the market and proper stability within the industry.
Q1571 Nick Ainger: Have you got any
idea when these warnings are issued by the Bank and by the FSA
if they are taken note of? You have just told the Committee that
they were and yet we ended up with the mess that the banking industry
got itself into in August. What measures or what further action
do you think particularly the FSA could be taking to ensure that
when they do issue warnings that action is taken by the banks?
Ms Knight: If I may say, you are
talking about one bank, not banks in general. There may well be
an institution in any walk of life that does not necessarily take
the appropriate action at the appropriate time, but in terms of
the industry and banks in general, do they act on warnings, the
answer is yes. Are they considered? We see that consideration
around the various committees that we operate within the BBA,
so we are well aware of the sorts of actions and the sorts of
issues that are addressed and how the industry in general addresses
them. I think also, though, the question is this: what is the
nature of the follow-up by the various authorities themselves?
Because I agree with you it is one thing to issue some sort of
communication and quite another to say that they have also put
in place the right tools and the right monitoring process to see
whether those actions have taken place. We do wonder whether that
is another area which warrants further review.
Q1572 Mr Love: In the press release
that you put out on behalf of the BBA on 5 December you are quoted
as saying: "The operation of the Tripartite was found wanting
when the Northern Rock problem arose." What changes would
you like to see to make it work better in the future?
Ms Knight: First of all, we do
support the Tripartite; we think that the problem is more in execution
than in structure. The piece of work that we want to see done
and, as far as I am aware, has not been done, and it certainly
is not yet in the public domain even if somebody has looked at
it, is this: if the various authorities had taken action earlier,
both regulatory and in respect of the Bank of England, with the
Northern Rock, would we have had a more orderly outcome? Certainly
the perception is that whilst issues were raised at certain points
in the timetable, actions by the authorities were far more `wait
and see'. For example, no changes took place within the money
market structure, there was no alternative or Plan B despite many
approaches, it appears, put it in place in respect of Northern
Rock. Before we know exactly what sort of changes need to be made
to the Tripartite, we need to have that piece of work undertaken
by our authorities; what would have happened if they had taken
action rather than wait and see. Clearly there is a question of
leadership within the Tripartite. There is also a question of
getting the right information reported at the right time. There
is also something about the individuals involved as to whether
it is at the right sort of seniority. Lastly, I think that there
is a lot of work being undertaken on financial stability within
the FSA but there are not all that many people on that side within
the Bank of England, and as far as financial services and the
Treasury is concerned, we would like to see that side strengthened
Mr Coles: Could I add one point
Q1573 Mr Love: Just before you do
that, Mr Coles, let me press Ms Knight a second. Is there an implied
criticism in what you have just said about the Governor's decision
in relation to the provision of liquidity at the very early stages
of this problem?
Ms Knight: Certainly as far as
the industry were concerned, they were looking for changes to
the money market in July in some degree of urgency and the question
about wider collateral and the penal rate had been on-going with
the industry for around 12 months. This is not an implied criticismI
am just stating the factsand I do not want to have that
terminology used. But there were certainly differences of view
of how the money market should operate and particularly when there
were what were referred to as `stress conditions'.
Q1574 Mr Love: Mr Coles, what was
your Association's attitude?
Mr Coles: For me, looking at the
Memorandum of Understanding, one of the key issues that is missing
from that is "which of the Tripartite authorities is responsible
for communication once a crisis has begun?" If you look at
the final paragraphs of the MOU, which is talking about crisis
management, neither the Bank, the Treasury or the FSA is responsible
for communicating with depositors, and I think that was one of
the key weaknesses on 13/14 September. Firstly, it was not clear
who was actually in charge of making that communication and, secondly,
as Hector Sants has said in his evidence to you, some of the terminology
that was used was inappropriate for the ordinary man in the street.
Who is in charge of communication when you have got a crisis problem
and where there is a crisis of confidence, which is essentially
a communication issue, is a very important improvement that needs
to be made to the MOU.
Ms Knight: That is right.
Q1575 Mr Dunne: Can I turn to the
issue of off balance sheet structures and transparency and disclosure.
Hector Sants, when he was here last week, said that we needed
to consider the use of off balance sheet financing. Could you
comment on whether you think there are mechanisms to bring particular
types of structures onto banks' balance sheet? Would that be welcomed
by the industry or would that be a problem for the industry?
Ms Knight: Of course, some are
already being brought back onto balance sheet, as you know.
Q1576 Mr Dunne: But by default.
Ms Knight: I think the wider question
is we are where we are, but should one be looking at other changes
in the future? Some of the points that we believe warrant further
investigation surround transparency and they surround some of
the way in which ratings agencies should operate. I do not want
to cast them as the devil in all this, but there are some issues
there. Also some of the accounting standards help as well. There
are some accounting standard changes which take place in effect
from this year and, which again give greater clarity in that area.
What we want to do is to see how these operate not park the issue,
but see how those accounting standards operate and take forward
with some degree of rapidity the whole question of transparency
and whether and what that provides in terms of furnishing the
right sort of information to the market. There is, dare I say
though, a proper role for confidentiality in everything; it is
getting that balance right.
Q1577 Mr Dunne: Do you think Basle
I is the culprit here in large part by allowing banks to provide
liquidity facilities to off balance sheet vehicles without having
to provide any capital adequacy?
Ms Knight: I think it is certainly
arguable now that Basle I is not the right tool for the job, but
we are up and running with Basle II. The market does move on and
standards do have to be reviewed frequently to ensure that they
keep up with the market. The whole question of looking at liquidity
is part of Basle II and that is the part that is underway at the
moment. One of the issues though is that you cannot look at these
things from just one jurisdiction. It is not possible to say,
"The UK is going to do this," because we operate in
a global market. Therefore I think that this area has come rapidly
up the agenda of Basle II and the discussions which have been
stuck for some time are now likely to be unstuck. I say again
liquidity has got to be looked at internationally and not just
in one jurisdiction.
Mr Coles: I think Basle II is
going to be particularly important because pillar three of Basle
II is all about market transparency. It is about institutions
giving much more information to the market about the nature and
structure of the balance sheet and the liabilities that they have
under particular circumstances, and that should aid the transparency
issue that you are talking about.
Ms Knight: Yes.
Q1578 Mr Dunne: Do you think the
FSA is equipped to regulate banks properly?
Ms Knight: Yes I do. I do think
they are equipped to do that. I certainly think that they need
to review how they do it. It seems to us in the industry that
there has been very considerable attention paid to capital and
very considerable attention paid to, the conduct of business rules,
but the gap in between has not had the focus that it should have
had. I appreciate that it almost seems year-by-year additional
requirements are placed upon the FSA to regulate more or regulate
differently, and I think we all understand the difficulty of addressing
that scenario. There is the very real problem now as to how the
FSA should be regulating banks and whether they do necessarily
have the right tools and the right people in place. That is where
they need to look. We think there is some strengthening that is
required and we would rather strengthen the existing system than
put a new system in place.
Q1579 Mr Dunne: Could I just press
you on the people aspect. Do you think the people within the FSA
have enough knowledge of the financial instruments currently being
used by banks and is there a retention problem at the FSA of people
with those skills?
Ms Knight: The answer to the first
question is clearly no, because if you are a practitioner in the
market, you see how quickly it is developing; if you are not a
practitioner in the market, you do not. Healthy regulation is
about interchange of people from the market into the regulator
and from the regulator back into the market. I know the FSA is
aware of this and they have been assuring the industry and the
wider public that they are paying attention to the quality and
calibre of people that they have. I think the industry does want
that to take place as well but I suppose we are sometimes guilty
of buying out good regulators at the same time. A flow between
regulator and industry and industry and regulator is important
in this, as it is in other areas as well.
Mr Coles: I think there is an
issue about consistency of regulation. I know of one large building
society, for example, that has had its relationship with the FSA
headed by five different people in four years. That does not give
the relevant people very much time to understand the nature of
the institution which they are supervising. I would like to see
someone doing a minimum of two or three years so that they properly
understand the nature of the business without being subject possibly
to regulatory capture.