Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1580 - 1599)



  Q1580  Chairman: In a word, Angela, is it a case of first-tier banks getting first-tier regulators and second-tier banks getting second-tier regulators?

  Ms Knight: I think I could argue that you want first-tier regulators with second-tier institutions—

  Q1581  Ms Keeble: I wanted to ask a bit more about transparency and disclosure following on from what Philip Dunne asked. Adrian Coles, you mentioned in particular the third pillar of Basle II. Do you really think that that would be adequate, given the problems which have been already encountered with an organisation which I think you said was already operating to Basle II standards?

  Mr Coles: I think there are two issues about transparency. The first is what is the nature of the bits of paper that are being issued by issuing institutions and are the people buying those bits of paper well enough informed to understand what they are buying. I do not think there should be intervention in that area. I think it is up to the people who are buying the paper to employ the experts to properly understand the nature of the financial arrangement that they are buying into. I think the more important question is when people invest in banks, should they know whether or not those banks have invested in risky bits of paper on the other side of their balance sheet? Pillar three is certainly going to give us much more information on that, although I am not aware whether Northern Rock has made significant pillar three disclosures since it got its IRB waiver at the end of June this year.

  Q1582  Ms Keeble: Can I just come back on that point because you said the banks should employ the people who are able to look into the investments and to work out—

  Mr Coles: —when they buy them.

  Q1583  Ms Keeble: That is right and, in a sense, the people who then invest in the banks are dependent on the banks doing that first bit properly. One of the things which has emerged through our discussions is that the due diligence is not adequate in terms of people looking into what lies behind the commercial paper. Do you think there is a real need for the banking sector to improve its due diligence so that when it discloses what it has invested in, it does not just say we have invested in these triple-A star rated securities but it says what is actually bundled up in those securities?

  Mr Coles: I think personally that would be helpful.

  Q1584  Ms Keeble: Could you say a bit more than just "it would be helpful" because otherwise we do not know enough about what your thinking is about what the banks should be doing.

  Mr Coles: Building societies typically do not invest in these pieces of paper anyway, so I think I will defer to Angela on that one about the nature of the investigation that should take place in due diligence.

  Ms Knight: It is a fair point. Firstly, so far as disclosures generally are concerned, IFRS 7 is one of the standards that is coming into force. I think that will certainly help on general disclosures—there are some others, as I have said earlier. Theses are all coming into place over a relatively short period of time. I think it is important to see exactly what clarity they bring. However, the answer to the point that you made about whether there has been too great a reliance on something being called triple A or triple B rather than a proper investigation behind, is that is probably the case. Certainly Basle II has brought the reliance on external ratings agencies more into the fold than I think was intended, so more needs to be done in respect of these agencies. We have put a list, which I hope we sent to you, of some of the specific issues that we think it is important to look at in terms of this whole area of transparency. One is clearer signposting between mortgage-backed securities based on prime assets and securitisation based on sub-prime for example. Another relates to the sort of actions that programme managers ought to be taking in terms of regular updating, disclosure of information, and so on. Are there more things that can be done? The answer is yes. Some of them do get into rather arcane-sounding language but the question is is it going to be more understanding, does it need to be more understandable, and those are the sorts of recommendations that the banks are making because better transparency is where they want to get to.

  Q1585  Ms Keeble: What are your criticisms of the credit ratings agencies?

  Ms Knight: I think they need to monitor their ratings more; I think they need to articulate why they have got to the ratings they have; and I think there is something about the separation of the provision of ratings from the financing of the agencies that is important as well.

  Q1586  Mr Breed: Is it not abundantly clear now that banks collectively have been totally irresponsible in lending vast amounts of money against worthless bits of paper?

  Ms Knight: No.

  Q1587  Mr Breed: How can you stack that up?

  Ms Knight: There is certainly a problem which has arisen, but it is by no means distributed evenly right across the banking industry.

  Q1588  Mr Breed: So they all knew exactly what they were lending against and the value of the pieces of paper that they were lending against?

  Ms Knight: As you will know, the exposure is different and no doubt the knowledge has been different as well, because some of these structured products are far more complicated than others.

  Q1589  Mr Breed: Some banks have been able to lend perfectly satisfactorily against asset-backed securities of which they knew the total value?

  Ms Knight: I think you will find that that is entirely correct. Some will have said that they want an exposure where there is a higher return and thus a higher risk, and that is also a perfectly reasonable lending decision for them to have taken. What is important here though is not should banks have a mixture of different types of lending, different types of analysis and different types of criteria—of course they should; it is an assessment of risk. If there was not that assessment of risk much of the financing of anything from British industry to industry around the world would not take place. What we have here, though, is probably a pretty unique—I sincerely hope it is unique—occurrence whereby what is, in effect, a serious housing problem in one country has, through the spread of risk, found its way around the world. Not just in the UK but to other financial centres as well.

  Q1590  Mr Breed: I think that is overly simplistic. Can I ask two quick questions. Was Northern Rock a member of the BBA?

  Ms Knight: Yes.

  Q1591  Mr Breed: And did it discharge all its responsibilities to the BBA properly?

  Ms Knight: As far as we were concerned, yes, it participated in committees and it took part in discussions around the committee. The responsibilities—

  Q1592  Mr Breed: There are a lot more obligations than that to the BAA.

  Ms Knight: The membership relationship with a trade body is, as you rightly say, something of a two-way street in that we are primarily there to assist our members, often on regulatory and tax issues, and lobby on their behalf. There is a two-way flow of information, but what we would not expect is for one of our members to talk to us about their business and commercial decisions; that is for them. We are there for the generic issues, the market issues and those things which are common to everybody. The Northern Rock was, after all, regulated by the FSA.

  Q1593  Mr Breed: So the announcement in August was a complete surprise to the BBA as well, was it?

  Ms Knight: The problem with the money market and the freezing up of the money market, which was 9 August—

  Q1594  Mr Breed: No, the problem with Northern Rock, your member?

  Ms Knight: That was in September.

  Q1595  Mr Breed: When did you become aware of the problems with Northern Rock, at the same time as all of us?

  Ms Knight: Yes, the Thursday evening when the leak occurred about the lender of last resort arrangements was the first time that we were aware of the situation.

  Q1596  Mr Breed: That one of your members was in failure essentially?

  Ms Knight: Correct. We were certainly aware of the concerns in the market and we had read the analysts' report. We had seen the share price fall and we had read the statement that the Northern Rock had made about its own finding issues, which was in June, so, yes, we were aware of the difficulties and we were certainly aware of the effective closure of the market, but we knew for certain at the same time as everybody else did.

  Q1597  Mr Mudie: If I could get some common ground between you and my colleague Colin Breed. Your defence of the banking industry is understandable by your position, but would it not be correct to say that some banks acted unwisely and maybe even irresponsibly in terms of these past months?

  Ms Knight: In which respect? I beg your pardon.

  Q1598  Mr Mudie: Are you sticking to the position that they are all as pure as the driven snow and that this was something that could not be avoided or are you agreeing that some of them perhaps now wish they had not got into certain business?

  Ms Knight: I am sure they do. I do not pretend the industry is perfect. I do think it does a good job but mistakes can be made. A lot of it is about a judgment call and I suspect that there are some people who, as you rightly say George, wish they had not invested in some of the stuff that they have invested in, yes.

  Q1599  Mr Mudie: I have certainly got the impression from some of the folk that have come before us that their lack of exposure was more down to timing; they got in late rather than in at the start and so their exposure was less, but it was not a question they were not in it because it was too profitable not to be in it.

  Ms Knight: It also depends on the type of business that you are running. Whether you are focusing predominantly at investment banking or are focused predominantly at the retail market, so that would also depend upon banks' exposures to sub-prime.

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