Examination of Witnesses (Questions 1640
TUESDAY 18 DECEMBER 2007
Q1640 Mr Fallon: Is it the case,
do you think, that the Government can now move quickly enough?
Mr King: Yes, but it is important
to get it right. I think that is why it is sensible to wait for
your report, for the Chancellor to have time to see the recommendations
from the Bank of England and from the Financial Services Authority,
then it will probably be sensible to have a period in which people
can discuss and debate the proposals and then you in Parliament
will have the responsibility of taking through this legislation.
That is not a quick process either.
Q1641 Mr Fallon: I understand that,
but if this was a need identified a year ago, it might seem to
our constituents that this is all taking rather a long time and
we are very exposed to another Northern Rock.
Mr King: That is why I think it
is important now to move quickly but not so quickly that we get
the detail wrong. At the end of 2006 I certainly did not anticipate
that it was likely that we would be faced with this problem during
2007, and I quite readily accept responsibility for that. I did
not say you have to do it by the middle of 2007; I said it is
important that we work on this, not let it just stand on the shelves
gathering dust but work on it, and we made that point and that
was agreed by all the participants in the tripartite meeting in
Q1642 Mr Fallon: But the minutes
said it was urgent?
Mr King: Yes, but "urgent"
does not mean rushing it in such a way that you get it wrong.
Q1643 Mr Brady: Can I return to something
Sir John said a little earlier. I think in relation to the lender
of last resort facility you said, "We knew it might not work
and, if it did not work, we had a choice between guaranteeing
all the deposits or allowing Northern Rock to go into insolvency."
Who made that choice?
Sir John Gieve: Ultimately the
Chancellor made the choice to offer the guarantee to depositors.
Q1644 Mr Brady: But I think your
comments referred to the time before the facility had been granted.
You were saying, "We knew in advance that if it did not work
we would have this choice to make"?
Sir John Gieve: Yes. All three
parties agreed that the next move was for the Bank to offer a
facility to Northern Rock to see if it could tide it through these
liquidity difficulties. There was no dispute on that.
Q1645 Mr Brady: But this question
of whether to give a 100% guarantee to depositors had been considered
before the lender of last resort facility was granted and a decision
had been taken not to do it at the same time as the facility was
Sir John Gieve: The form of the
guarantee, I do not think, had been discussed. We were offering
a secured lending facility and, if that did not work, then the
question was: would we continue to offer however much money it
needed or not? We knew that that would require a government guaranteethat
was not something the Bank could do off its own balance sheetso,
in that sense, there was a further choice beyond the secured facility
on whether to just provide whatever funds were needed or to let
the bank go into administration, but we thought it was worth,
as a first step, having a go at helping Northern Rock through
Q1646 Mr Brady: To be very clear,
specifically on the guarantee to retail depositors, that was something,
therefore, that had been considered before the facility was granted
and a decision was taken not to extend that guarantee at that
Sir John Gieve: We decided not
to make an explicit guarantee that all depositors would get their
money come what may, and at the time I still think that was a
reasonable judgment. In retrospect, of course, we did not reassure
the depositors because we did not offer that guarantee on the
Friday, so we had to offer it on the Monday.
Q1647 Mr Brady: Who made that decision
at the time?
Sir John Gieve: On Thursday?
Q1648 Mr Brady: At the time previously.
At the time that you decided not to extend the 100% guarantee
to retail depositors at the same time as
Sir John Gieve: The decision for
us to offer a secured facility was the Bank's decision, authorised
by the Chancellor.
Q1649 Mr Brady: I am asking about
Sir John Gieve: The decision not
to go further than that was a tripartite decision in which, I
think, all three parties were at one.
Q1650 Mr Brady: Can I move on and
ask you, Governor: when you gave evidence to us in September you
told us very clearly that, "As a result of the Market Abuses
Directive in 2005, we were unable to carry out a covert lender
of last resort operation in the way that we would have done in
1990s." It has been reported since that the European Commission
does not agree with that view. Is that because the text of the
directive is different from the UK legislation that enacts it,
or is it matter of differing opinions on the same text?
Mr King: There are certainly differing
opinions in the legal world on that and, I can tell you, the final
resolution of whether there could or could not be a covert operation
was reached on the Tuesday before the facility was given. It was
a decision by the FSA, supported by the tripartite legal advice,
on two grounds, one under the listing requirement and Northern
Rock's obligations as a listed company, which the FSA is responsible
for, and secondly, under the Market Abuses Directive. We were
advised by the FSA that under both it would require Northern Rock,
not the Bank, to make a public statement to the fact that it had
the facility. I should say that Northern Rock were very keen to
make a public statement that they had the facility. Their view
was that they did not want the covert operation; they wanted it
to be overt because they believed that the sign of reassurance
of having a facility from the Bank of England would help them
and, in fact, that is what would prevent a retail run in their
view. Obviously, sadly, it did not turn out to be the case, but
the legal advice was clear, though I gather now that, at least
on the Market Abuses Directive, there is still a difference of
view between the interpretations of some in the UK and some in
Brussels. There are also some differences in interpretation between
the original advice we had and the current advice that is being
received. Somehow this still needs to be resolved, but, frankly,
it is not the most important issue, because I think the Chancellor
was absolutely right in saying that the facility of the size required
would almost certainly become public knowledge, so it was not
really an issue worth pursuing. Nevertheless, that is an issue
to be resolved still on the table. I think, from my conversations
with central bankers from around the world, they are very conscious
of this case and they recognise that, irrespective of what the
law says, in practice now it may be extremely difficult for lender
of last resort operations to be conducted in the covert way that
they were even in the early 1990s, where what happened has still
not been revealed. I think that there is a challenge for central
banks to think about how they intervene, which all of us will
want to think carefully about.
Q1651 Mr Brady: The legal advice
on the Market Abuses Directive, I think you said, came from the
Mr King: Yes, it was the FSA's
advice but it was taken by the lawyers involved in the tripartite
arrangements. There were lawyers from all three bodies.
Q1652 Mr Brady: Would you be willing
to share that advice with the Committee?
Mr King: I would have to take
advice as to whether the lawyers will allow us to do that. Often
this advice is given as a matter of legal privilege. I think I
need to consult on that. I personally do not feel strongly about
it, but I think I do need to take advice on that.
Chairman: I think that is a wise answer,
Q1653 Mr Love: Is it inevitable that
Northern Rock will be nationalised?
Mr King: I do not know. I do not
think anything is inevitable. I think it is still possible that
it may be. Until January we do not know what the state of the
financial market conditions will be. I do not think you can rule
out the possibility that a management team will be able to obtain
the degree of financing that will enable it to become the preferred
bidder and for that to lead to a successful bid. I would not want
to speculate on what would happen. It is very difficult to do
Q1654 Mr Love: We are told that it
would need to raise around £15 billion, mainly to pay back
part of that that has been loaned by the Bank of England. Is there
any possibility that they can do that in the timescale, especially
since quite a lot of the shareholders, hedge funds in particular,
seem to be briefing against them?
Mr King: I see two aspects to
that. The first one is that, of course, part of the original bids
did include a proposal from the bidders to raise money and pay
back at least the initial Bank of England lender of last resort
facility. That has become more difficult in the last couple of
weeks because of the deterioration in sentiment in the financial
markets, but if those were to improve in the New Year, that may
come back onto the table again. The second thing I would say is
that the difficulty of reaching a reorganisation of Northern Rock,
which is absolutely, desperately needed, is made much more difficult
by the fact that the shareholders can block what seems to be a
sensible discussion of reorganisation by the people who are financing
the vast bulk of the balance sheet, and it is precisely that problem
to which the idea of early, prompt, corrective action and having
an agency that can intervene in a failing bank before it reaches
the stage of insolvency which is, in my view, so important. It
is why all the other G7 countries have introduced a mechanism
like that, and the FDIC is perhaps the best.
Q1655 Mr Love: Turning to the tripartite
arrangement, do you think there is a need for drastic surgery
to the tripartite agreement?
Mr King: No, I do not think there
is a need for drastic surgery. I think the bits of it that were
described explicitly in the Memorandum of Understanding, which
set out the responsibilities of the three partners, worked pretty
well, but what did not work so well was that there were issues
that came up that were not described in the Memorandum of Understanding,
and the most important ones to me are the absence of sufficient
instruments available to the authorities to deal with a failing
bank. That is why I put so much weight on the importance of the
three points I made to you at the beginning this morning. I think
if we had the power to intervene earlier, if somebody had the
power to intervene earlier, and there had been a different deposit
insurance system, then I do not think the problems with Northern
Rock would have led to the outcome that resulted.
Q1656 Mr Love: Would you accept the
criticisms about lack of co-ordination between the tripartite
partners and, if so, what changes do you think are necessary to
Mr King: I think the co-operation
worked well. It is clear that the shock of seeing Northern Rock
get into such difficulty and the television pictures of depositors
on the street really made a big impact on people, but I do not
think that in and of itself means that the co-ordination of the
tripartite authorities did not work. As I said, when it occurred
we simply did not have the instruments to deal effectively with
Q1657 Mr Love: I was intrigued by
your statement. You include knowledge of a discussion paper on
liquidity regulation being produced by the FSA. I wonder whether
you would care to commentI am assuming that you have been
consulted in relation to this as wellas to whether it addresses
issues of co-ordination between the tripartite partners?
Mr King: Yes, it does, because
it makes very clear that, whatever regulation FSA adopts in an
improved sense to regulate liquidity, it will want to co-operate
and work with the Bank of England, because the way we conduct
our money market operations will clearly have implications for
the way they choose to measure liquidity and decide how to regulate
it. But there is a very important point that was made by Professor
Charles Goodhart in an article he wrote on liquidity a month or
so ago, where he said that there is no single number in measuring
liquidity that will tell you the true story. It is no good just
looking at the amount of liquidity you have got for the next two
weeks, or the next four weeks, you need to look at a range of
numbers and apply a qualitative judgment as to whether or not
the institution has adequate liquidity. I do think it is important
that this be taken much more seriously because, as I said, the
Northern Rock is an extraordinary example. Here was a bank that
adopted the Basle II method of capital regulation and, as a result,
found that it had one of the highest capital ratios of any bank
in the UK, proposed to return that to shareholders and yet it
was in a very vulnerable liquidity position. That shows, if anything
does, that capital is not all. That is not a criticism of Basle
II, Basle II is designed only to look at capital, but it does
mean that, in parallel with it, you do need a proper regime of
regulation of liquidity and the discussion paper the FSA will
publish tomorrow is the first step on the process of making sure
we get one.
Q1658 Mr Love: There have been suggestions
and, indeed, comments made that perhaps the way to address the
tripartite arrangement is to create a new body that would come
into play exactly in the circumstances that happened in relation
Northern Rock. Would you have any sympathy for that type of reordering
of the way in which the arrangements operate?
Mr King: What I think is most
important is that we actually create the powers for some authority
to intervene pre-emptively in a failing bank akin to the FDIC.
Where that is located I do not have strong views on, and that
is something that can be discussed. What is most important is
that someone has got it and can exercise it.
Q1659 Mr Love: You are not minded
to suggest that that should be with the Bank of England?
Mr King: No, because the one principle
that I have pursued absolutely to the limit while I have been
Governor is that we have never fought any turf battles. I would
much rather give up any pretence that we should be involved in
this than for the UK not to have these powers available to some
authority. It is not my objective to try to acquire or accumulate
powers in the Bank, it is my only objective to make sure that
the UK has a system of resolving failing banks that works, and
we do not have one at present.
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