TUESDAY 11 DECEMBER 2007

SIR CALLUM MCCARTHY, MR HECTOR SANTS AND MS LORETTA MINGHELLA

  Q1500  Mr Fallon: Sir Callum, if Northern Rock cannot find the funding it needs to finance its operations without nearly £29 billion worth of support from the taxpayer, how do you still describe it as solvent?

  Sir Callum McCarthy: Because we have looked at the assets it has and the demands on those assets and believe that those assets meet those demands. The amount that has come from the taxpayer is secured against the assets of Northern Rock.

  Q1501  Mr Fallon: But if it is not able to finance its future liquidity, how can you regard it as solvent?

  Sir Callum McCarthy: Because there is a distinction between liquidity and solvency.

  Mr Sants: We are clear that it would not meet its thresholds conditions if it were not for the availability of the finance from the Bank of England.

  Q1502  Mr Fallon: But you still think it is solvent?

  Mr Sants: Yes. In clear accounting terminology, threshold conditions is regulatory terminology and we have answered the question.

  Q1503  Mr Fallon: Yes. I think you have also explained to us exactly what has been happening. You have said there are regulatory lessons to be learned here and you are going to publish a discussion paper on liquidity. Is that right?

  Sir Callum McCarthy: No, there are two quite different things and let me explain what they are. One is a paper on liquidity as a general set of issues and, as Hector said, we plan to publish a discussion paper on that before the year end. The second and quite different aspect is that we have undertaken to do a review of the way in which the FSA discharged its responsibilities in relation to Northern Rock during the period up until August and we have undertaken to do that and publish the results of that in March and that is not a discussion paper, it is a quite forensic investigation.

  Q1504  Mr Fallon: Will that include the possibility of somebody else supervising liquidity?

  Sir Callum McCarthy: No, this is to do with the question of how the FSA discharged the responsibilities it had up until August 2007.

  Q1505  Mr Fallon: I thought we were pretty clear now that you did not discharge your responsibilities. We have had the worst banking crisis for 140 years. Somebody failed.

  Sir Callum McCarthy: I repeat, we are looking at the lessons that we are going to learn.

  Mr Sants: We have already said quite clearly that we think the supervisory process with regard to Northern Rock in the period prior to July should have addressed the liquidity issues through more aggressive engagement around the question of stress testing and ensuring that the board, whose primary responsibility is ultimately to run the institution, fully understood its business model and its limit to its business model and the risks it was running. We would agree with you that process did not take place, so the purpose of the review will be to ask the questions as to why that did not take place and what lessons should be learned from that. That is about our application of our regulatory regime as it then was. There is then a second question as to whether or not the regulatory regime should be modified which will be looked at through the combination of the liquidity discussion paper and, of course, if there are any issues relating to the tripartite review, that will be handled through the tripartite review. We are in no way not acknowledging the fact that our supervisory engagement with Northern Rock prior to July should have looked into these scenarios and it would appear on the reading of the file to date not to have done so.

  Q1506  Mr Fallon: If you were charged with supervising banks, including their liquidity, and you failed, is not one of the answers to return that supervisory duty to where it once was, which is to the bank?

  Mr Sants: I think we need to look at a couple of points here and they will come out in the review. There is a question as to whether or not the overall regulatory proposition is in some way flawed and in addition whether the narrow engagement of that group of supervisors with that institution not properly discharged. It would be wrong to prejudge the conclusion of these various reviews, but my preliminary thoughts would suggest that the approach we were taking in terms of emphasising stress testing in principles-based regulation was right. I do not think that events here undermine the basic regulatory philosophy of principles-based regulation, the crux of which is about asking management to take responsibility for the outcomes and consequences of their decisions and you could well argue here that is something the board should have been doing more rigorously than it was. I do not think the philosophy of regulation is undermined here, there may well be questions, I think there are questions, as I have just indicated, about the particular engagement with this particular company. As to the question of whether or not it would have made any difference if administratively those supervisors had reported to the bank rather than to the FSA—Sir Callum may wish to comment—I do not think there is any evidence at all if the reporting line of that supervisory department had been moved that would have made any difference to the set of circumstances which transpired prior to July, nor would it have made any difference to the information being passed over to the relevant part of the bank with regard to monetary operations during the course of August and September.

  Sir Callum McCarthy: Could I just add one point, which is I think that the idea of transferring banking supervision separately from insurance and security supervision is an idea that has severe disadvantages.

  Q1507  Mr Fallon: It is a pretty severe disadvantage with the background and all the damage we have seen to British banking as a result. You seem to be simply defending your empire. The supervision of liquidity was done perfectly well by the Bank of England until you started it in 1997.

  Sir Callum McCarthy: People can have different views on the ability of different supervisory regimes historically. I would point out that if you look at the problems that the events have caused, they have caused severe problems in Germany, where banking supervision is shared between BaFin and the Bundesbank, so the idea that making bank supervision the responsibility of the Central Bank is the answer to these is not necessarily supported by the facts.

  Q1508  Mr Fallon: You think you are still the best people to supervise banking liquidity?

  Sir Callum McCarthy: I believe that it is impossible to take the question of banking liquidity from overall supervision. There are questions, as Hector has absolutely indicated, about whether we did that sufficiently well, but I do not believe you can take bank liquidity supervision from other aspects.

  Mr Sants: Also you have to ask the question, what particular benefit do you think would accrue from aligning a supervisory group with a money markets management group; a central banking liquidity function? There is no particular evidence that the issue with regard to Northern Rock would have in any way been changed by that alignment. I think you do have to ask the counter-factual question what is it you think would have been brought to this issue that was not brought to the issue as a result of making that organisational change.

  Q1509  Mr Breed: Could I return to your view on the solvency of Northern Rock. I think you said that there is a difference between solvency and liquidity. Of course, one of the tests of solvency is all to do with liquidity and, indeed, the vast majority of businesses that go bust go bust because they have not got cash, not because they have not got assets, so liquidity is a fundamental of solvency. That test is that a business can meet its obligations within the normal course of its business and therefore looking forward, including in Northern Rock's case, of course, the repayment of £25 to 29 billion—whatever it is—of taxpayer's money, and I understand that is in place until February, do you, therefore, believe at this moment in time that Northern Rock is solvent on the basis that it can meet all its obligations within the normal course of its business, including that taxpayer's loan to it?

  Sir Callum McCarthy: The answer is yes. We would not deem it solvent unless we believed it could do that. The fact that it is getting liquidity from the Government is undoubtedly the case and without that liquidity the bank would have failed.

  Q1510  Mr Breed: It is totally dependent upon the Treasury contribution which lasts until February according to the Chancellor. By February, when the taxpayer may expect to have all its money back which would be in the normal course of its current business, you expect that to happen which is an assessment therefore of its solvency today?

  Sir Callum McCarthy: No, I do not think we are necessarily saying that we believe the taxpayer will have all the money which has been advanced returned by February because I think if you look at the Chancellor's statement he said February or the time at which other events have been reached. It is clear that the Treasury, in discussions with the bidders, has been prepared to discuss timetables for repayment which go beyond that. All that is in the public domain, I am saying nothing new.

  Q1511  Mr Breed: You consider that sufficient to consider that Northern Rock remains solvent?

  Sir Callum McCarthy: We do believe that Northern Rock remains solvent.

  Q1512  Mr Breed: Could I ask finally then, when is Northern Rock's next trading statement to be published?

  Mr Sants: The next trading statement would come with the final results.

  Q1513  Mr Breed: Is there not one due in the middle of December?

  Mr Sants: That would be its pre-close and then it would have to make a full statement by the spring.

  Q1514  Mr Breed: We are now 11 December, so within the next few days you would expect Northern Rock to produce an interim trading statement?

  Mr Sants: Coming back to the quoted company point you have just made, I think it is clear to investors that without the support provided by the Bank of England at the current time then Northern Rock would not be able to continue in its current form. There has to be a presumption, as Callum has already laid out, that support would remain in place unless an alternative mechanism can be put in place, to justify continuing the meeting of the threshold and conditions, and that analysis is correct. In a narrow sense we are clearly dependent on that funding stream to continue to make the assertions we have made and that is absolutely right and any statement by the company will have to reflect that.

  Q1515  Mr Breed: Just to repeat, you are expecting the company to make its interim trading figures available by the middle of this month?

  Mr Sants: It would make a pre-close statement and then a statement after the end of the year.

  Q1516  Mr Breed: You are expecting that to happen?

  Mr Sants: In order to fulfil its listing conditions it will have to so do.

  Q1517  Mr Breed: If it does not, then its listing might be in jeopardy?

  Mr Sants: Its listing could be in jeopardy.

  Q1518  Mr Dunne: With hindsight, should the lender of last resort facility have been extended to Lloyds TSB in order to have allowed a private sector solution?

  Sir Callum McCarthy: I think it is very difficult to form a judgment on that because, as I think I said last time I was before this Committee, it was not quite as cut and dried as I think it has been suggested that there was a complete proposal on the table. It was the case that it was made clear slightly later than that that the facility which had been offered to Northern Rock would be offered to other bidders, ie they could take advantage of it, but it is a difficult set of circumstances to take a view on even in hindsight.

  Q1519  Mr Dunne: You just explained that you do not believe it would be appropriate for liquidity supervision to be separated from regulatory supervision and the regulatory supervision restored to the bank. Do you think there is an alternative scenario in which the liquidity supervision should be brought into the FSA so it is brought under a common roof?

  Sir Callum McCarthy: No. There is a question about whether the only route providing finance should be via the Bank of England or whether the Government should have other agencies that it could use. I think that is something which is a possible route. I should make clear that I am not arguing for the FSA to have a very large balance sheet. That is the last thing I want.

  Mr Sants: We obviously have a mandate to facilitate private sector solutions and, as was demonstrated by the retail bank point you just made, you could argue that is a difficult mandate to discharge when the FSA has no locus with regard to providing funding with regard to institutional specific situations. That is a question that could be reasonably considered but, as the Chairman indicates, there are different ways that mechanism could be considered.