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Rock: MPs v Darling

• Robert Peston
• 26 Jan 08, 08:47 AM

France has one, Switzerland too. The UK has a big'un, Germany numbers two or maybe more, and the US has a veritable epidemic of them.

As if you didn't know, I am talking about banks that have become chronically sick since last summer.

It's why the prevailing mood in Davos is anxiety - or at least among the business leaders and politicians from the wealthy, old economies of Europe and North America.

Among the roll-call of western banking shame, our own Northern Rock humiliation is special.

The damaged banks from the other countries were all terrible lenders, or foolish in the way they invested their capital. That includes Societe Generale, even if it was the victim of deception.

Northern Rock was a disastrously bad borrower, far too dependent on wholesale money markets for the finance needed to provide mortgages.

It was starved of vital sustenance last summer when those wholesale markets closed: its undoing was the crisis of confidence in the financial community precipitated by the disclosure of just how idiotic its international rivals had been as lenders.

Which is why the Rock had to demand succour from the Bank of England - and why it's now on a 拢60bn lifeline provided by the Treasury.

But, make no mistake, for a bank it's as much a sin to take excessive risks as a borrower as it is to do so as a lender. A drying up of access to funding or liquidity will kill a bank just as surely as lending to those who can't repay.

So who's to blame for the Rock debacle? Well, we now have the first official evaluation, in the form of a report by MPs on the cross-party Treasury select committee.

Most at fault, say the MPs, were the Rock's directors for constructing a flawed business model; then the City watchdog, the Financial Services Authority, for failing to spot the flaw in the business model till it was too late; then the Bank of England, for being unimaginative and inflexible in the way it provided funds to the banking market after it seized up.

Few will quibble with that verdict. And it's certainly fashionable to give the FSA a good kicking. That said, it is worth noting that no British bank has been exposed as a lethally poor lender - for which, perhaps, the FSA deserves modest credit.

However it's the select committee's prescriptions for reform that will prove more controversial.

It seeks to address the widely acknowledged holes in the powers of the authorities to cope with a bank that runs into difficulties.

What seems to be required is:

a) the ability by the authorities to obtain more information at an earlier stage from any bank facing trouble;

b) greater powers to direct the offending bank to mend its ways;

c) a system for formally taking control of a bank on the brink of crisis, to quarantine the depositors and take them to safe harbour, while reconstructing or deconstructing the rotten part of the organisation;

d) deposit-protection arrangements that provide comfort to depositors that they can't lose money or access to their money.

The logical place for most of these new functions to go would be the Financial Services Authority - or at least that's what the chancellor thinks, and he'll flesh out his reform proposals in the coming week.

By contrast, the Select Committee is proposing the creation of a new semi-independent financial-stability body that would sit within the Bank of England. It would be run by a re-invented deputy governor of the Bank of England, who would have no direct reporting line to the governor on banking remedial work.

The committee has put the chancellor in a tricky position. He can't really ignore the verdict of a Labour-controlled committee. But presumably he can't simply abandon most of his own ideas.

The big issues here are whether the creation of this new bit of the Bank of England would lead to excessive duplication of costs and functions with the FSA - and whether it will enhance or undermine effective decision-making.

One committee recommendation would, I think, be impossible for the chancellor to adopt. That would be for the banks to "pre-fund" a new deposit-protection scheme or make substantial cash injections into it.

Although it is vital that we all have total confidence in the robustness of such a scheme, right now none of our banks have a surplus of spare cash.

It may be better to take an IOU from the banks than to drain them of liquidity at a moment when they're feeling the pinch - and the economy is paying a price in the form of reduced availability of credit.

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