Business
A failure of regulation
Published 20 September 2007
There is a bank crisis in Britain every decade - but in the case of Northern Rock, Gordon Brown's actions as chancellor are coming back to haunt him
By my reckoning, the failure of the Newcastle-based mortgage bank Northern Rock was long overdue. Recent history shows that Britain has a banking crisis once a decade. In 1973-74, at the height of the oil crisis following the Yom Kippur War, it was the fringe banks that went under and the then mighty NatWest (now part of the even mightier Royal Bank of Scotland) that came under scrutiny.
In 1984 the Bank of England had to come scurrying to the rescue of the banking division of the historic firm Johnson Matthey. At the turn of the 1990s the infamous Bank of Credit and Commerce International, riddled with fraud from Miami to the City of London, was allowed to go under, followed by Barings in 1995, when the rogue trader Nick Leeson ended the life of an institution dating back to 1762.
All these instances of British banking failure, and in some cases rescue, have a theme in common. When the crisis is over, regulatory mistakes are nearly always seen to be among the problems. Somewhere among the boxes of documents in the regulators' vaults, or these days in the back-up computers that hold the email records, is a killer document or memo swept under the carpet or ignored by those responsible.
As a financial journalist who has monitored such scandals for more than 30 years, I am in absolutely no doubt that the same will be found with Northern Rock. Not because I believe that the amiable Northern Rock boss, Adam Applegarth, is a fraudster like the chaps who ran BCCI or like Leeson at Barings, but because the regulators allowed him to act in a manner which eventually was so obviously irresponsible, that they should have blown the whistle before taxpayers' money had to be put at risk.
A number of obvious questions should have been asked long ago. How is it that a second-tier lender, far smaller than the main clearers HSBC, Barclays, Royal Bank of Scotland and HBOS (which owns the Halifax), managed to snap up a 19 per cent share of the mortgage market over the past six months?
Why was it that Northern Rock, alone among British banks and mortgage lenders, was so dependent on unreliable wholesale markets for its funding? Seventy-five per cent of its funding came from these markets. Like the notorious American sub-prime lenders, the Rock had packaged up the mortgages of ordinary British borrowers and arranged for them to be turned into securities that were then sold for cash. Just 25 per cent of the Rock's deposits came from ordinary retail customers.
Most of Britain's big banks split 50:50 between wholesale and retail funding. The Nationwide receives 75 per cent of its funding from retail deposits (generally far more stable, though more expensive to operate, than those subject to the vicissitudes of international finance) - the obverse of the Rock.
Responsibility for Britain's current regulatory arrangements rests wholly with the former chancellor-turned-Prime Minister, Gordon Brown. The second leg of his experiment with an independent Bank of England was to remove banking supervision, which had long rested in Threadneedle Street, to the new Financial Services Authority. So controversial was this at the time, that it provoked a bitter exchange of letters between Brown and the then governor, Lord (Eddie) George, and almost caused the latter's resignation.
The Rock crisis has been the first real test of the new regime for banking supervision, with the Bank of England responsible for maintaining financial and economic stability and the FSA in charge of monitoring individual institutions. It has worked badly, with the authorities forced into a series of late and hasty decisions.
A more alert regulator than the FSA would have recognised some time ago that Northern Rock's way of running its business made it peculiarly vulnerable to changes in wholesale money market conditions. But there is no evidence that it issued any warnings until the Rock's board acknowledged it could no longer run its own affairs and was looking for a rescue bid.
Past Bank of England regulatory errors had made Brown nervous of leaving financial supervision in the hands of the Old Lady of Threadneedle Street. And yet, in many ways, the Bank, because it is in daily contact with overnight money markets, is best placed to see and hear trouble and head it off. This is certainly the way in which the Federal Reserve in the United States and the European Central Bank have acted during the present crisis, triggered initially by American sub-prime mortgages.
Britain, with its split regulation, has the worst of all worlds, and Northern Rock customers and investors have been ill-served. It took the personal intervention of the Prime Minister and the Chancellor, Alistair Darling, fearful of losing a reputation for economic competence, to calm matters. But it is hardly a performance that inspires confidence.
Alex Brummer is City editor of the Daily Mail
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