Bank regulation system branded a disaster

Nov 14 2007 by William Green, The Journal

THE system of bank regulation introduced by Gordon Brown was yesterday branded an “invitation to disaster” even before the run on Northern Rock.

Financial experts told the Treasury select committee the tripartite system bringing together the Bank of England, Financial Services Authority (FSA) and the Treasury was “flawed” in design.

And the regulators’ response to the global credit crunch and the ensuing problems at Northern Rock was strewn with errors, said Professors Willem Buiter and Geoffrey Wood.

Prof Buiter accused the FSA of being “asleep on the job” and failing to express stronger concerns about the “breakneck” rate of Northern Rock’s expansion, and insisted covert lending was possible in contrast to what the Governor of the Bank of England said.

Prof Buiter, who sat on the Bank of England monetary policy committee, said: “I think that particular statement of the Governor is just not correct that there is nothing in the appropriately titled MAD directive [of the European Union], the market abuses directive, to prevent covert support to banks in trouble.

“On the day he said it, the statement was contradicted by a spokesman for the [European] Commission and every lawyer I have spoken to since then says that they have no idea where that indication came from.”

Prof Buiter added that the structure was “flawed” and “risky” in that the FSA was responsible for supervising individual banks, while the Bank of England had the resources as lender to act in last resort.

“It is possible if they are lucky to manage it, but it is an invitation to disaster to delay,” said the academic based at the London School of Economics.

And either the FSA or Bank of England should have the individual information and money to do something about banks having problems, said the academic.

Prof Wood, of Cass Business School, claimed the structure was fundamentally flawed and accused Chancellor Alistair Darling of making confusing statements.

The Bank of England was slammed for not providing liquidity to UK banks in contrast to American and European counterparts as global money markets froze up in response to problems in the US mortgage sector.

The criticism comes after Northern Rock was hit by the money markets’ difficulties and was forced to get support from the Bank of England.

Prof Buiter said such support should have been in place within the system while the Chancellor, Gordon Brown, the Bank of England governor and FSA chief executive should have issued an immediate joint statement reassuring people money was safe.

The immediate creation of a deposit insurance scheme that worked was desirable rather than the “unnecessary” delay that happened, he added.

Both academics said the savings of individuals should be fully protected between £35-50,000 to assist “widows and orphans”.

More controversially, MPs heard suggestions that it might have been better to let Northern Rock sink or swim.

Other options could include taking banks into administration without freezing savings or taking them into public ownership and managing them as a going concern until their future is resolved.

Newcastle Central MP Jim Cousins, a committee member, said: “There is no doubt at all that as far as we know Northern Rock was the first serious test of the regulatory system and the regulatory system failed.

“And now all the people involved in it are running for cover to find excuses and to try and lay the responsibility off on somebody else. It really is very unimpressive and troubling.” The Labour MP suggested other banks were drawing on Bank of England support and warned against any “artificial” deadline for Northern Rock that would cause the loss of thousands of jobs.

“We have to hold out for a North-East headquarters of a significant retail bank employing thousands of workers, listed on the British stock exchange,” he added.

The Chancellor has previously said the system worked but there were lessons to be learnt.

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Injunction taken out after leak

NORTHERN Rock has taken out an injunction against publication of the contents of a business memo sent to potential buyers.

The memorandum contained financial information about the bank. Details appeared on a newspaper group’s website.

A spokesman said Northern Rock had obtained the injunction, “...in order to protect the integrity of the information which has been provided to potential purchasers, and to help ensure it can implement its strategic review in a way designed to achieve the best outcome for the company and its stakeholders.”