TUESDAY 11 DECEMBER 2007

SIR CALLUM MCCARTHY, MR HECTOR SANTS AND MS LORETTA MINGHELLA

  Q1520  Mr Dunne: If Northern Rock is nationalised, will Granite have to be nationalised too?

  Sir Callum McCarthy: I am sorry, it is a hypothetical question and I do not know the answer at all.

  Mr Sants: Granite is, as you know, an on-balance sheet vehicle in that sense. I know the obligations which are carried by Northern Rock to Granite would have to be carried through the nationalisation process, I would imagine.

  Q1521  Mr Dunne: That would survive? Events of default would not be triggered or it could be organised so they did not trigger through a nationalisation, do you envisage?

  Sir Callum McCarthy: It is difficult. It would depend on the details of the Granite trust.

  Mr Sants: It would depend. I have a view, but I am hesitant to express a definitive view. I could send you a note on it. I am pretty sure that it could be organised in such a way, but I hesitate to be absolutely definitive.

  Mr Dunne: If you could send a note, that would be appreciated, Chairman.[1]

  Q1522  Mr Brady: When we took evidence from Northern Rock it was not readily suggested that the first contact specifically about the liquidity problems between the FSA and Northern Rock was initiated by Northern Rock and not by the FSA. I think, Mr Sants, you were interviewed for the File on Four programme. You gave the opposite answer and said it was the FSA that initiated that contact.

  Mr Sants: Sorry, I have got a very bad cold. I actually could not hear the question.

  Q1523  Mr Brady: Who first contacted whom regarding the liquidity problems at Northern Rock? Was it the FSA contacting Northern Rock or vice versa?

  Mr Sants: My understanding of the events—I think, as always in these things, it is a question of how you perceive them—from our point of view, we contacted them first in the sense that, just to be clear, we always understood the funding model of Northern Rock, as I think I have explained before, so from the moment that market conditions deteriorated and we set up our special process from 10 August and so forth, if you remember the earlier discussion, we were proactively engaging with the firms that we perceived as carrying risk and that includes Northern Rock. Northern Rock may have been answering the question in the sense that clearly, as the company, it would be their judgment as to when they had a serious problem, so in that sense they might have rung us and said, "We now do officially think we have a serious problem", but from our perspective we were contacting and proactive with Northern Rock as an at risk firm once market conditions had deteriorated from 9 August. I believe, as I said on the programme, that we were proactively engaging with Northern Rock and that was the case.

  Q1524  Mr Brady: That dated from 9 August?

  Mr Sants: I think from 10 August actually.

  Sir Callum McCarthy: Could I make a distinction between after the events crystallised on 9 August and before I think it would be a misleading impression to suggest that the first time we had ever discussed liquidity, those issues, stress testing, was 9 August.

  Mr Sants: Yes, I did not think that was the question. I think I made clear earlier that in July we had already started to point out to the firm, recognising that we could have been doing this before, that we were very unhappy with their stress testing scenarios and asked them to do "further distinct liquidity tests and scenario tests" and give greater consideration to the impact of accelerated cash flows from a trigger event in a liquidity crisis, so that communication was already taking place with them in July and that was proactively initiated by us.

  Q1525  Mr Brady: What advice did the FSA give to the Chancellor about the need for an immediate depositor guarantee after the lender of last resort operation was leaked?

  Sir Callum McCarthy: The announcement was made on the Friday and, as you say, it was leaked on the Thursday night. Over the weekend there was a series of conversations with various Treasury officials and the Chancellor in which the need to give an explicit government guarantee was discussed and the decision was taken on the Monday afternoon.

  Q1526  Mr Brady: What advice did you give?

  Sir Callum McCarthy: The advice was that if the run that was taking place continued, the only way of stopping it was an explicit government guarantee.

  Q1527  Mr Brady: Could I also then ask about the advice that was given prior to the leak or the announcement being made. The Governor has pointed out there was no easy way to predict the response of the customer, but is it not really common sense that in those circumstances without 100% guarantee there would be a state of panic created?

  Sir Callum McCarthy: No, I do not think it was obvious. I think that a whole series of things conspired. It was extremely unfortunate that the information leaked because it meant that instead of this being put in place as, "This is a solvent institution which has a cash flow problem and the Government is stepping in to make sure that it is saved", it became a panic measure or a response to something that was already in the making. Panic was how it was seen. I think that it was unfortunate that the administrative arrangements within Northern Rock were not better developed, both in terms of the Internet access which was inadequate and something which very little could be done about at all, which was the physical layout of the branches. One of the problems in these circumstances is because of anti-money laundering requirements, if somebody comes in and says, "I wish to withdraw £20,000", it takes something like a quarter of an hour to go through all the necessary steps. If you have a small branch with two counters, you only need ten people and you have a queue. There was a whole series of things that were difficult, some of which with more favourable timing we could have overcome; some of which we could not. Also, I think in retrospect it would have been better to have emphasised the positive aspects rather than the negative aspects of lender of last resort.

  Q1528  Mr Brady: Did the FSA advise the Chancellor that there should be the guarantee put in place at the same time as the lender of last resort?

  Sir Callum McCarthy: No, we did not, nor did anybody else, nor would I have wished to have given that advice because it would clearly have been better if the lender of last resort facility had been put in place and had worked without a general guarantee.

  Q1529  Mr Brady: Again, I think I am quoting correctly from the File on Four programme, Mr Sants, on this subject you said—I think this refers to the FSA and the Chancellor collectively—"We obviously had made the judgment that it wasn't an announcement we wanted to make at the same time as the facility". That implies this was at least discussed.

  Mr Sants: To be fair, I think this particular programme is an edited programme, not a live programme, so I am not sure I can particularly recall the question to which I was responding or, indeed, can be sure from the transcript what the question was I was responding to. I was not involved in everyday conversations with the Chancellor but I concur with the analysis the Chairman has given. I do not think we specifically gave any advice with regard to the 100% guarantee prior to the news breaking.

  Q1530  Mr Brady: As you say, the programme is edited but in the transcript I have got in front of me, your actual words in response to this point were: "We certainly discussed the possibility, but we obviously made the judgment that it wasn't an announcement we wanted to make at the same time as the facility", so it was the possibility of it.

  Mr Sants: My recollection of the discussions, I have to say these were not specifically with the Chancellor, was that they were about alerting the FSCS i.e. we were talking about the way in which this announcement would interact with the compensation scheme. We were, of course, aware of the limitations of the scheme and, indeed, as we said before in our consultation paper, which was a precursor to the changes we have announced, and the Chairman mentioned at the beginning, we made clear the scheme was not structured to address a large scale failure in the banking system. This is the point we had already made in public. What I was seeking to reflect in that comment, I believe, from memory, was the fact that we had been talking about those issues, but we had not given specific advice as to whether the matter should be addressed prior to the announcement.

  Q1531  Mr Brady: You did not give advice one way or the other?

  Mr Sants: Not personally to my recollection, none of us did.

  Sir Callum McCarthy: My recollection is that the question of the guarantee only arose after the queues began to develop.

  Q1532  Mr Brady: Yet it was discussed before that?

  Sir Callum McCarthy: Hector has explained the context in which he made that remark.

  Mr Sants: The compensation scheme was discussed beforehand. The issue of 100% guarantee was certainly not discussed at the principals' level. I think I may have some vague recollection of it being mentioned by some working group discussion, but that is the extent of it.

  Q1533  Mr Brady: Do the Tripartite Authorities have a communication strategy for coping with a bankrupt?

  Sir Callum McCarthy: I would say a better one now than we did some time ago.

  Mr Sants: That was the point we made when we were here before. We absolutely do think that there are significant lessons to be learned in terms of the way the Tripartite Authorities communicate around these types of issues, both the terminology and the way we handle the release of the news. We have already started to learn from those lessons and continue to so do.

  Q1534  Mr Brady: One final point. If I could come back to Ms Minghella. How involved were you at the time all of this was going on and how confident, in particular, were you that the FSCS could cope with the failure of Northern Rock had that happened?

  Ms Minghella: We were not involved in August with the discussions with the Tripartite Authorities when they were going on. We became aware of the problems of Northern Rock in particular in September. I think a point that has been made earlier with Mr Todd was that we were not designed to deal with a failure of this size, so it was not a surprise to us that these discussions had been going on in advance of our being informed. By the time we found out the lender of last resort facilities were already in mind and that seemed to us to be appropriate in the circumstances.

  Q1535  Jim Cousins: Sir Callum, if a bank were to be nationalised, how would that affect the workings of the tripartite committee?

  Sir Callum McCarthy: I think that it would depend on who was the owner of any nationalised bank because we do not have responsibility for supervising the Bank of England or any subsidiary of the Bank of England, so if an institution became a subsidiary of the Bank of England, we would not supervise it. If it were a freestanding, if I can use that expression, nationalised bank, we would supervise it.

  Q1536  Jim Cousins: Is this something that has been discussed by the tripartite committee, how its own workings would be affected in the event of the nationalisation of a bank?

  Sir Callum McCarthy: I am not aware of any discussions. I have not taken part in any discussions. I am not sure if there have been any.

  Mr Sants: I am not aware of it in the way I think you are asking. The Chairman has already answered in terms of understanding the supervisory framework, but in terms of the specific tripartite question, I am not aware of any discussions.

  Q1537  Jim Cousins: You are obviously aware, Sir Callum, that there is a campaign to downgrade the value of the assets in Northern Rock and force it into nationalisation, that campaign has been in front of the Committee this morning. What regulatory consequences do you think there would be if one of the members of the tripartite committee itself became the owner of a bank?

  Sir Callum McCarthy: Sorry, I should make clear that I do not understand the reference to downgrading the assets.

  Q1538  Jim Cousins: I am not suggesting you have done that.

  Sir Callum McCarthy: I am not sure in terms of the tripartite arrangements if there were a nationalised bank whether that would have very great effects on the tripartite arrangements overall.

  Q1539  Jim Cousins: If a nationalised bank were to seek to wind up its operation rapidly by selling its assets in the market in a short time frame, would that be something that would come before the tripartite committee?

  Sir Callum McCarthy: Were there a nationalised bank, whoever was running that nationalised bank would have responsibilities, it would have responsibilities presumably under the Act of Parliament that had led to the nationalisation. In terms of the FSA's regulatory responsibilities we would be concerned, as with any institution, about systems and controls, adequate management, all those things, but it would not be for us because we would not be the shareholder—the shareholder would be the Government in some form or other—to decide on the commercial strategy of that institution.