Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1640 - 1659)

TUESDAY 18 DECEMBER 2007

MR MERVYN KING AND SIR JOHN GIEVE

  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 2006.

  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 granted.

  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 guarantee—that was not something the Bank could do off its own balance sheet—so, 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 its problems.

  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 time?

  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 the decision.

  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 FSA?

  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.[3]

  Chairman: I think that is a wise answer, Governor.

  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 so.

  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 improve co-operation?

  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 it.

  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 comment—I am assuming that you have been consulted in relation to this as well—as 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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