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Taking stock of the Rock

• Robert Peston
• 23 Sep 07, 10:03 AM

Time to take stock of the astonishing consequences of Northern Rock鈥檚 decision to apply for emergency help from the Bank of England on September 13.

Here is where we are today:

1) The Government is underwriting all deposits in the British banking system; it has said that no depositor need fear the loss of a bean, thereby incurring a potential liability to the public purse on a mind-boggling scale.

2) The Treasury has very specifically insured almost all forms of lending to Northern Rock, so it has done what would normally be the unthinkable, which is to provide a public subsidy for the value of Northern Rock鈥檚 shares.

3) The Bank of England has belatedly provided the kind of three-month lending facility to the banks which it resisted doing just weeks ago 鈥� and which could well have prevented the crisis at Northern Rock, if it had been made available in early September.

4) The Chancellor has signalled that the existing system for insuring deposits at banks is to be swept away and replaced with one that gives greater protection and pays out with greater speed.

5) City confidence in the ability of the Bank of England to cope with this kind of crisis is very badly shaken.

This is the equivalent of the wreck of a city after an earthquake. So where does blame lie for this disaster? Here is the preliminary roll-call of responsibility:

a) If at the heart of Northern Rock鈥檚 problems was a business model that was too dependent on the money markets, then its management are first in line for criticism 鈥� and second in line are its non-executive directors, for failing to rein in the exuberance of management (and if you want an illustration of how blinkered they all were, both Northern Rock executives and non-executives were still buying shares in Northern Rock at the end of July and in early August).

b) Again, if the underlying cause was Northern Rock鈥檚 shaky business model, it is reasonable to ask whether the laudable aim of the City watchdog, the Financial Services Authority, to provide freedom for banks to innovate and flourish went too far in this case.

c) The Bank of England seems to have shown too little imagination in the way it provided funds or liquidity to money markets after they seized up on August 9. Its obsession with not rewarding banks for their bad behaviour seems to have made it blind to the option of flooding the market with cash, but making that cash expensive (both in terms of discounts or the 鈥渉aircut鈥� applied to collateral and a high interest rate). Such funds would have allowed Northern Rock, for example, to continue trading without the stigma of applying for an emergency loan. And Northern Rock would have been suitably spanked, because its profits would have been wiped out by the pricey terms of these funds. For what it鈥檚 worth, the Chancellor Alistair Darling signalled in The Times on Saturday that he would now favour a 鈥渕ore generalised system of bank support鈥� along these lines 鈥� though the words 鈥渂arn door鈥�, 鈥渉orse鈥� and 鈥渂olted鈥� come to mind.

d) Banks are bemused by how little direct contact they have had with the Bank of England during the money-markets turmoil of the summer. This may in part be due to an understandable desire by the Bank of England to avoid duplication of effort with the Financial Services Authority. However it is difficult to see how the Bank felt confident to refuse the agonised demands of the banks and the FSA for more liquidity to be pumped into the market 鈥� as the Bank consistently did 鈥� unless it had first-hand knowledge of the scale of the problems at individual banks. This may point either to a failure at the Bank or a failure of the tripartite alliance of Bank, FSA and Treasury (which was created by this Government around ten years ago and was supposed to be the optimal system for coping with banking crises).

e) The decision-making efficacy of the tripartite alliance doesn鈥檛 look brilliant in a second respect. There is something very odd about the Treasury sanctioning the Bank to provide lender-of-last-resort funds to Northern Rock when the Bank and the FSA were more-or-less persuaded that the inevitable consequence would be a run on Northern Rock (largely because of the inadequacies of the deposit-protection system). The four-day delay in announcing that the Government would not allow any depositors to lose money made their fears come true. A banking crisis was transformed into the national humiliation of the first run on a British bank for 141 years. Was this delay the result of Treasury reluctance to expose the public-sector balance sheet to the problems of Northern Rock? Were the Bank and the FSA poor in communicating their intimations of doom to the Treasury?

These are important questions. Hooray that they will be examined by the Treasury Select Committee. But arguably there should be a proper public enquiry of a wholly non-political sort.

However, if there is already a single glaring lesson of the Northern Rock debacle and the wider problems in money markets, it is that the global regulatory system has put too little emphasis on the risks of liquidity crises. As a matter of urgency new rules have to be drawn up to ensure that all banks have proper emergency plans in place to secure access to cash in the event that it becomes difficult to obtain through normal channels. Oh, and it might make sense for the Bank of England to review its own emergency procedures.

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