THE queues that formed outside the branches of Northern Rock last Friday brought back memories of newsreel footage of the run on banks during America’s Great Depression.

In Britain, confidence in our financial institutions is something we take for granted. But in recent times the collapse of Barings and BCCI, and the troubles faced by life assurers just four years ago after the rout in stock markets, are a reminder of their fragility.

Yet Northern Rock’s decision to seek emergency support from the Bank of England seemed closer to home. The public may not have understood the opaque world of money markets and liquidity crunches that caused its problems, but they did not like the threat of one of the pillars of the high street toppling into ignominy. The problem may have started with American homeowners defaulting on dodgy mortgages, but it was now on their own doorstep.

Customers queued up to withdraw deposits because they feared, despite reassurances, that the bank was on the verge of going bust. The 32% fall in the share price on Friday was another sign of just how deep the sense of panic was.

Northern Rock is the most public UK casualty of a financial crisis that started in America and has spread internationally.

These are dramatic times, but it is not Armageddon. In a strange way, Northern Rock may have owned up to its problems just as the storm passed. In the event, Adam Applegarth, the bank’s chief executive, lost his nerve, and so did the Bank of England.

But there is always a point when price draws people back in, however risky the backdrop may appear, and by the end of last week the liquidity crisis that has brought money markets to a grinding halt started to show signs of easing. The gap between overnight rates and three-month rates is offering a margin of at least 50 basis points – half a percentage point. That is the nearest you are going to get to a risk-free investment, particularly when you are providing three-month paper to institutions such as HSBC and Citigroup.

The reason this arbitrage is staying around is because hedge hunds – the traditional buyers of these products – are busily reducing their exposure. That means that international institutions such as central banks, pension funds and Middle Eastern governments are taking advantage of these rates. While this is encouraging, the recovery will be slow and the conditions that allowed Northern Rock to sell retail assets through wholesale markets will remain closed.

The aftermath of the storm will result in lawsuits and questions over why and how banks in China and Germany got sucked into holding commercial paper that was worthless. Over the next few months some of the world’s big investment and retail banks will also be making provisions against some of their reckless behaviour.

But the City has not closed for business. Bankers I spoke to last week said that deals were now being worked out on earnings multiples that were the norm in 2005, and returning to those more conservative valuations is no bad thing. Lenders will reprice risk and, as a result, spreads will widen. The big companies are cash-rich and undergeared. Inflation in China is a problem but the country is still growing at breakneck speed. The stock market has defied everything and is still above the levels seen nine months ago.

What world markets now need is clarity and some of that will be given this week when investment banks report. But alongside headline-grabbing provisions the bigger question is consumer confidence. It has been damaged by this affair and if house prices ease the consumer could quickly sound the retreat.

Not a part-time job

IF there is one job you don’t want at the moment, it is chairing the audit committee of a high-street bank. It is tough enough for an insider to try to understand, but for an outsider who holds a part-time position, it is close to impossible to be confident that you know where all the potential problems are hidden.

The job of an audit committee is to review the internal control system for the board. In today’s sophisticated markets the ability to find people capable of understanding the exotic products that some of their bonus-hungry dealers have been writing is becoming ever harder. And even if you do have the requisite skills to police backroom boffins, don’t forget it is only a part-time, nonexecutive job. As this column has stated before, increased regulation is an inevitable consequence of this cycle that has led to banks becoming increasingly exposed to ever more risky vehicles.

But banks should also look at the way they run their audit committees. For instance, is Ewan Brown really equipped to chair Lloyds TSB’s? He is a successful businessman and sits on the board of Noble Grossart, the Edinburgh merchant bank, and Stagecoach. But he is far removed from the City.

And what about Rona Fairhead – head of HSBC’s audit committee? She is a contender to succeed Dame Marjorie Scardino as chief executive at Pearson, but the HSBC role is too big a job for a part-timer.

Then there is Anthony Hobson, who runs HBOS’s audit committee and sits on the board of several other companies.

While our current system of corporate governance holds sway, such individuals can only try to ensure that all the processes are in place beneath them to root out the bad news. I find it hard to see, however, that anyone, no matter how able, would be able to do this properly on a part-time basis.

john.waples@sunday-times.co.uk

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