THURSDAY 25 OCTOBER 2007

RT HON ALISTAIR DARLING MP, MR NICHOLAS MACPHERSON, MR MARK NEALE, MR RICHARD HUGHES AND MR CLIVE MAXWELL

  Q747  Chairman: Chancellor, good morning and welcome to the Committee. As you know, we are taking this session in two parts, the first on the issue of financial stability and transparency, which we hope to spend the first three-quarters of an hour or so on, and then on the issue of the PBR and the CSR. On financial stability and transparency, we will be hearing from you again in January, at the conclusion of our inquiry, and it would be good if you could confirm in advance of your final report on deposit protection and other related banking issues that this would fit in with your timetable.

  Mr Darling: Yes, it would.

  Q748  Chairman: Thank you. Could you please introduce yourself and your colleagues.

  Mr Darling: I can confirm I am the Chancellor. With me there is Clive Maxwell, who is the Director of Financial Services and, with your permission, after we have finished the first part of the meeting, he will withdraw since he is solely concerned with that area. Nick Macpherson, the Permanent Secretary, you know, as do you know Mark Neale, who is the Managing Director for Tax and Welfare and Richard Hughes, who is in charge of the Comprehensive Spending Review.

  Q749  Chairman: Thank you very much and welcome. Considering that we have had the first bank run in the United Kingdom for about 140 years, how successfully do you think the Tripartite Authorities have handled this situation?

  Mr Darling: There are certainly lessons to be learned. My starting point is this, that what happened in the second part of August and early September was very dramatic. It started in the United States; it rapidly spread from there to the rest of the world and affected us here in Britain. The fundamental problem was that, whilst there was plenty of capital available, the banks and other financial institutions became very reluctant to lend to each other and there was an acute shortage of liquidity. That affected Northern Rock in particular because of its particular business model. It had aggressively expanded its market share earlier this year and was very dependent on being able to get hold of wholesale funding on a very regular basis and it became clear from the middle of August onwards that it was finding it increasingly difficult to do so. When that became apparent to the authorities in the middle of August, they did a number of things. Firstly, the FSA worked intensively with the Northern Rock bank to try and resolve its liquidity problems by helping it get access to more money, helping it with the securitisation that it had planned and which it depended upon. It also had discussions with, I think, two institutions which showed some interest in acquiring either part or all of it but of course, unfortunately, these did not materialise and, as you know, Northern Rock found it progressively more difficult to get funds even at a price that it was prepared to pay and eventually it had to come to the Bank of England for specific support. Obviously, I am happy to go into further details there as you want but my view of this is that fundamentally the structure we have in this country, where you have the Financial Services Authority which is responsible for the prudential supervision of individual institutions, is right. We have the Bank of England which is responsible for the stability of the financial system. I would take a great deal of persuading that you should merge these two. I think that would be very problematic and certainly I do not think anyone would argue we should go back to where we were ten years ago when we had seven or eight different regulators. I think there are lessons to be learned in relation to the interface between the Bank and the FSA. Both of those institutions, the FSA when they came to see you a couple of weeks ago, and the Bank of England in its Financial Stability Report which it published this morning, recognize that there are lessons to be learned in the way that we dealt with this in this country as well as there being international lessons of course as well.

  Q750  Chairman: We will be having both the Bank of England and the FSA before us again before your report, Chancellor. The Northern Rock run started on 14 September but the announcement to the changes in the depositor protection scheme for Northern Rock customers was only announced on 17 September. Why was there a delay in recognizing that additional action was required?

  Mr Darling: If we go back to the night of the 13th, that is, the Thursday night before the announcement was made, you will recall that I think it started to appear in the early evening news bulletins on the BBC that Northern Rock had sought facilities. Our intention was to make a statement, in common with market practice, at seven o'clock the next morning. The reason for that is the directors of Northern Rock had, understandably, decided they had to issue a profits warning and that it would have been disingenuous not to have mentioned that they were going to the Bank of England for facilities but the stories started to appear in the BBC and, of course, the queues started to appear outside some Northern Rock branches the next day. I frankly do not think that the issue of a guarantee or the extent of the cover under the depositors' scheme was an issue on Friday. It suddenly became an issue over the weekend, which is why I decided that we would put a guarantee in place on the Monday. Guarantees, as you know, are by no means unproblematic and, as you have seen with Northern Rock over the last few weeks, the nature and extent of the guarantee is quite a complicated thing. I think the issue of a guarantee or people's concern about whether or not they could get all of their money out did not really become an issue until over the weekend. Frankly, on the Friday—and indeed, it has been the case ever since—people could always get their money out of the bank, as they can today if they want to do it, but I think I was very clear by the weekend that, unless I went further than what I had been saying from Friday through to Sunday, and said, to put the matter beyond all doubt, "We will guarantee the retail and also the wholesale deposits", their problem would have continued but the guarantee itself was not an issue on the Friday morning when those queues started to build up.

  Q751  Mr Fallon: Chancellor, when did you personally first hear that Northern Rock might be in trouble?

  Mr Darling: On 15 August.

  Q752  Mr Fallon: So four weeks before the bank run. In this Tripartite system that you and Mr Brown designed, of Governor, Financial Services Authority and Chancellor, who was in overall charge?

  Mr Darling: In terms of the Tripartite Committee?

  Q753  Mr Fallon: Who was in overall charge?

  Mr Darling: Ultimately it is the Chancellor. As I said in the House of Commons a couple of weeks ago, I am pretty clear about that. There are discrete responsibilities. As I said, the FSA on prudential supervision and the Bank in relation to financial stability through its market interventions, but the whole point of having a committee is to allow all three institutions—because the Treasury is the backstop, if you like, in all these things—to be intimately involved. I said that I was first told specifically of Northern Rock on 5 August; a great deal of work was being done by the FSA and the Bank between the 15th and the time that ultimately Northern Rock had to come for specific lender of last resort facilities.

  Q754  Mr Fallon: But for a month the three of you could not agree on the safe haven option, you could not agree on a covert rescue operation, and when the bank run started, you then took four days to put in place proper saver protection.

  Mr Darling: No, none of that is true. Firstly, in relation to what happened during that month, as the Governor told you when he appeared before the Committee, whilst we were told there were concerns about Northern Rock at the first Tripartite Committee on the 14th and, as I said, the Treasury and I were formally told on the 15th, at that stage it was by no means certain that all was up with the bank. Northern Rock was able to get finance; it was finding it progressively more difficult but initially it was able to get access to finance. That is why the FSA, as they have said in a memorandum to you,[1] were working closely with the Northern Rock bank to see whether or not they could help the securitisation, they could help get additional funds. On 29 August the Chairman of the Financial Services Authority, Callum McCarthy, wrote to me formally drawing my attention to the fact that he thought Northern Rock then had quite real problems. I think it was the following Monday that the Tripartite Committee, the Governor, the Chairman and myself, met. We agreed two things. One is that, because of the systemic importance of maintaining Northern Rock, we would have to support that bank but, in addition, it was agreed that where it might be appropriate, generalised support to the whole market would be made, and indeed a couple of days later, the Bank of England did put £4 billion into the system. I just want to emphasise to you that during that four-week period there was a great deal going on. The problem was that by the beginning of September it was widely known in the market that Northern Rock was very exposed and they were willing to pay to get the facilities but they were simply drying up. In relation to the covert support, the safe haven point, by which I presume you mean another company, there was one slight expression of interest from an institution but that never came to anything. There was one more specific interest, although after two or three days that went away as well, although they did reappear after the bank had got facilities. In relation to covert support, we were clear from the time it became pretty certain that Northern Rock had severe problems that, if necessary, it would be able to get lender of last resort facilities. The problem was—and I said this in the House last week—that that I was always very sceptical whether or not you could do this covertly simply because today's market conditions are very different.

  Q755  Mr Fallon: OK, but looking at the system as a whole that you put in place to protect us against this kind of fiasco, the plain fact is that you were told on 14 August by Northern Rock that they were going to run out of money.

  Mr Darling: No, that is not true.

  Q756  Mr Fallon: Through a triangle of indecision and dithering, four weeks later they did run out of money.

  Mr Darling: Northern Rock did not say on 14 August "We are going to run out of money." What happened was the FSA said on 14 August it believed that, because of Northern Rock's particular business model, because of its exposure, it was the concerned about it in general. That problem began to crystallise at the end of August, when it was clear that this was not just a generalised worry or a suspicion but that actually Northern Rock was running into quite substantial problems. As I said to you, during that period prior to the end of August and after that until the middle of September, extensive efforts were made to try and resolve the problem with Northern Rock. Remember, Northern Rock is and remains the property of its shareholders and it is run by its directors. We were trying to work with them to try and resolve this position because as time went on we became increasingly concerned about that. In relation to the general problem that we faced, I said right at the start that I think there are lessons to be learned, both in terms of the regulation, because if you look at Northern Rock, look at the exposure it had and realise just how dependent it was on being able to get funds on a daily basis, if that line of funding dried up, as it did, what was its fallback position? The answer in Northern Rock's case is that they did not have a fallback position. Other institutions like Countrywide in the United States did have standby credit lines to banks. Northern Rock did not appear to have that sort of safeguard. Work was being done but I am in no doubt that we need to learn from this, firstly, I have mentioned I think, better international surveillance. We have international institutions which could be used far more effectively, and that is something that we started work on when we met in Washington last weekend. In relation to the position domestically, the FSA have said, and it is right, that they do need to look at their procedures and how they regulate things. The Bank of England has said today that, having regard to what happened over that period in August and September, it too needs to ask itself how it would intervene, whether in a general sense or a particular sense, because it does worry me; I think central banks do need to be able to intervene in ways that sometimes, in the public interest, are not overt.

  Q757  Mr Fallon: The FSA and the Bank have admitted their responsibilities, their failures. Why will you not admit yours? You are in charge of the system. This is the first bank run for 150 years. You failed.

  Mr Darling: As I said to you right at the start of this session, I accept responsibility for what happens at the Tripartite Committee. The Chancellor ultimately is responsible for these matters. I said the same thing in the House of Commons last week. I am very clear about that. What I want to do though is to make sure that we learn from what has happened here. I think there are changes that need to be made, particularly in the interface between the Bank and the FSA. There are changes too that we need to make in relation to the deposit protection scheme, which is perhaps the third point that you mentioned in relation to the guarantee because much better than a guarantee in future would be a system that would allow us immediately, in the event of a bank failing, to isolate the depositors' funds and pay them out as quickly as you reasonably can. Therefore there would be absolutely no reason whatsoever for a depositor with Northern Rock to be concerned about whether or not their money was safe. As you know, we are consulting on that now.

  Chairman: That is one aspect we will be actively looking at in our inquiry.

  Q758  Mr Simon: When I asked Sir Callum McCarthy do you think the Tripartite arrangements work, which is hardly a trick question, he said, "I think that they do work. Each of us has discharged responsibilities." He did not actually add "admirably" but that was definitely his attitude. Everybody who has been here has told us that the Tripartite arrangements worked and it has all gone fine, and yet we had a run on the bank. There is a huge reality gap which is baffling us all.

  Mr Darling: Firstly, I do not think, as you rightly say, anyone has used the word "admirably" or anything like that. My starting point, as I said to Mr Fallon a short while ago, is that I think having the FSA responsible for prudential supervision and the Bank of England responsible for the general stability of the market is the right model, and it is a model that most countries in the world are moving towards. The Tripartite Committee is simply a mechanism for bringing those three things together but when you ask was it able to stop Northern Rock seeking funds, no, it was not, but I think it would be wrong in your analysis to say that if only the Tripartite Committee was different or it had functioned differently, this would not have happened. The big problem was the fact that liquidity dried up following the failure of the sub-prime market in the United States. That problem affected America, it affected the Far East, it affected Europe, there were problems in Germany, some in France, as well as a problem with a particular bank here. In deciding what we do next, we have to be clear about what the problem was in the first place and I do not think it was the structure of the committee that was the problem.

  Q759  Mr Simon: Is it the problem that the structure of the Committee was not sufficiently able to respond to the changing needs of a fast-moving situation, was not sufficiently dynamically responsive to a crisis, and that a new structure needs to be thought of which is more responsive to these kinds of extreme pressures?

  Mr Darling: You can always improve structures and you can always make changes but before you do, you need to work out what the problem was in the first place. The general problem was the fact that liquidity dried up. The next problem was that you were dealing with an institution, Northern Rock, which was hopelessly exposed. Let us deal with those two problems first of all. One is a generalised problem. I think there needs to be better international surveillance, there needs to be better regulation to stop banks from hiding things off-balance-sheet, and there needs to be questions asked on the precise role of what credit rating agencies do. There are all sorts of things you need to do there. The second thing in relation to Northern Rock, I am quite clear that regulators need to start looking far more at liquidity and not just solvency. They tend to be more concerned about solvency. Northern Rock is and was solvent and it is unusual. Mr McFall was asking about banks in the past. BCCI, for example, was insolvent; Barings became insolvent. With this bank that was not the problem; it was the fact that you could not get ready cash. In relation to how the bank and the FSA and ourselves react to those things, yes, there are lessons to be learned. I think the FSA needs to have more visibility of what the consequences might be on an institution like Northern Rock on the wider system and, as the Governor himself has said in the report published by the Bank of England this morning, the Bank of England needs to focus more on what happens if a particular institution gets into trouble on the wider stability of the system.