People in the North East must feel badly let down. Northern Rock is a model
corporate citizen, handing out large sums every year to support good causes
in the region. It is a very important part of the North East’s economic,
social and cultural life.
It is a highly efficient operator, with a good-quality loan book. In a country
where financial power is concentrated in the City of London, it stands out
as an institution with its heart and ambitions driven from a different
perspective. It is proud to be a major employer in the region, and one of
its few big plcs. But it has been seriously damaged by the events of recent
weeks.
Let me say right up front that the board of Northern Rock must take full
responsibility for the bank’s business model – which has left it more
dependent on the capital markets for its finance than other similar
institutions. That is what made it vulnerable to the perfect storm that has
blown through the global financial system.
Other financial institutions around the world have been buffeted. Few of them
have been holed. Could the outcome have been less damaging for the Rock?
We don’t yet know the detail of who said what to whom as the drama unfolded
over the summer. But we do, I think, know enough to say that the crisis has
not been well handled by those responsible: the Government and the City
authorities.
The pundits are now saying that Northern Rock was an accident waiting to
happen. But these are often the same people who, earlier this year, were
recommending Northern Rock shares at more than £12 a time. And if the
business model was so obviously vulnerable, where were the regulators as the
bank stepped up its expansion in the early months of 2007?
We now know that, by August 14, the City authorities were well aware that the
bank faced difficult times. But then more than four weeks passed before the
announcement that Northern Rock had been forced to seek help from the Bank
of England as lender of last resort – news that triggered the long queues
outside the bank’s branches as depositors began to withdraw their money.
Their confidence was restored only when, after several days of uncertainty,
the Chancellor made the unprecedented announcement that their deposits would
be fully guaranteed by the taxpayer.
According to the Financial Services Authority (FSA), Northern Rock is solvent,
exceeds its regulatory capital requirements and has a good-quality loan
book. And yet the summer weeks passed, and despite frantic activity behind
the scenes in the City, the problems were not fixed.
From my point of view, there’s no sense in looking for individual scapegoats.
Mervyn King, the Governor of the Bank of England; Sir Callum McCarthy,
chairman of the FSA; Alistair Darling, the Chancellor: so far as I am
concerned, they are all intelligent, hard-working people doing their best to
serve the public interest.
The problem, I believe, lies more in the system itself. This was the first big
test of the so-called tripartite arrangement, created when the Bank of
England was given its independence ten years ago. The deal then was that the
FSA would supervise individual banks, the Bank would deal with systemic
crises and sign the cheques, and the Treasury would – when necessary –
provide public funding to keep sound institutions in business.
For whatever reason, this tripartite system has failed to deliver the goods.
Perhaps there are just too many conflicts inherent in a system where three
different institutions, with three different policy priorities, have to come
together to tackle a fast-moving crisis.
And communications were not good enough. For example, the news that the Bank
was coming in as lender of last resort may have given some reassurance to
the banking industry, but it scared the life out of savers, and you can
understand why. It is not enough to say, as the Governor did last week, that
the main difficulties had been created by the complexity of today’s company
law, and by our system of deposit guarantees. You do not wait for the cinema
to catch fire before you check out whether the fire precautions are going to
work.
Whatever the explanation, the events of the summer have cast a shadow over the
future of Northern Rock. The reputation and standing of the UK as a world
financial leader has also been tarnished. Outside the movies, a run on a
bank is something that happens in a banana republic. That one should have
happened under our noses, in a mature and prosperous country such as the UK,
is almost unimaginable.
Of course, what has happened here has to be put into a much broader context.
What we have seen around the world in recent months has been a crisis of
confidence, and of trust, in the financial system. After years of more and
more ingenious financial engineering, the markets arrived at a point where
nobody knew the scale of potential liabilities in the event of trouble, or
where those liabilities lay.
A downturn in the US housing market was all it took to show that the emperor
had no clothes. Banks everywhere started to hoard their cash and were
unwilling to lend to each other for anything other than the very short term.
In a sentence, the markets gummed up.
This won’t last for ever: indeed, there may already be early signs of life
returning to the US money markets. But here in the UK, it will take more
than a few months to erase the memory of those depositors patiently queueing
to withdraw their funds. Those images will have weakened the public’s trust
in our financial system.
There is also a big question mark hanging over how our banks are going to
return to normality. The Chancellor has effectively socialised the banking
system by guaranteeing the deposits in Northern Rock and, by implication,
any other big bank. That was the price he had to pay to restore the
confidence of depositors.
But this is not a sustainable solution. As I see it, there are two very
different paths ahead.
If the taxpayer is going to back bank deposits for anything more than the
short term, then banks are going to need massive regulation to prevent them
taking risks. But that would kill competition and punish innovation. It
would severely limit consumer choice and clog up the arteries of our
economy. Unless we are careful, there is a risk that what has happened in
recent weeks may push us in this unwelcome direction.
The other route, vastly to be preferred, is to return to a world where market
forces operate. In that world, depositors are protected by adequate
guarantees, but shareholders lose their money and managers lose their jobs
if things start to go wrong.
Getting from here to there will require careful analysis followed by decisive
policymaking. First, we need to understand the strengths and weaknesses of
the tripartite arrangement, now that it has been tested and found wanting.
How can the responsibilities of a monetary authority like the Bank of
England best be aligned with those of a financial regulator like the FSA?
Who should have overriding authority in the event of a crisis?
The next step will be to consider whether the regulator needs more authority
to examine a lender’s business model, and how the legal complications
identified last week by the Governor can be fixed. The lender-of-last-resort
process will certainly have to be reassessed. And the deposit protection
scheme needs to be reviewed carefully.
It is hard to see how Northern Rock can return to its former glories any time
soon. But we must learn the right lessons from what has happened, so that we
never see such shocking sights on our streets again.
Richard Lambert is Director-General of the CBI. This is an edited version
of his speech to the CBI’s North East annual dinner last night.
