Northern Rock and Banking Reform

I will not follow the Chairman of the Treasury Committee, the right hon. Member for West Dunbartonshire (John McFall), in a detailed analysis of what went wrong after the events at Northern Rock, although I want to add my tribute to the way that he led the inquiry and drove us forward to produce a report that has been warmly received, not just on both sides of the House but more widely in the City and beyond. The debate today is timely. We are in a financial banking crisis, and I do not think that we are near the end of it. We see a loss of confidence in commercial banking, the freezing of the bond markets and, perhaps still to come, the probable unravelling of the carry trade. I start from the position that there is probably no financial crisis that the Government or politicians cannot, if they try, make worse. We should be extremely wary of every temptation to try, not least because not all but some previous regulations certainly contributed to our present discontents. Basel I drove the search for yield off balance sheets. The Sarbanes-Oxley Act drove the search for yield across the Atlantic, fired up the City and all our financial services sectors and perhaps made every British building society consider itself the next Morgan Stanley. Some aspects of Basel II may well be unhelpful in binding the extremely conflicted credit rating agencies into the regulatory structure. The answer may not necessarily be instant, knee-jerk regulation. It is just worth looking at the Government's consultation paper. It comprises 29 proposals for new legislation, 11 different rule changes for the Financial Services Authority to consult on and a further 23 significant operational changes to the ways in which banks operate—plus a whole load of other stuff, dealing with Scottish and Irish banknotes or the composition of the Court of the Bank of England, which may not directly help us to unfreeze the bond markets but seems simply to have been stuck in there. Of course, we have to deal with the failure of Northern Rock. Why did it fail? Who failed? The answer is that they all failed: senior management made mistakes and the non-executive directors failed to check them; the regulator failed to supervise the firm and the tripartite committee failed to keep it out of trouble; and the Chancellor at several key points failed to act promptly and decisively. Even so, I am wary of wholesale legislative reform. The first general point—and our Chairman, the right hon. Member for West Dunbartonshire made it—is that regulators must do their job. The FSA did not do its job, as the report makes clear. Of 3,000 staff, only three were directly employed in looking at Northern Rock—the only significant UK bank without a London office. The ARROW—Advanced, Risk-Responsive Operating FrameWork—process, under which Northern Rock was supervised, was conducted once every three years; and the chairman and chief executive lacked any formal banking qualification. We should recall that this was one of the fastest growing UK banks. Like the Chairman of the Treasury Committee, I do not necessarily think that we ought to be impressed by the need for tidiness. When we asked the tripartite committee how its members did their job, we found that, as the right hon. Gentleman said, they all liaised and consulted and all did their little bits. Some degree of regulatory overlap would be useful and, so far as the larger banks are concerned, I would like the Bank of England to be given some overlapping power, like the Federal Reserve, to go anywhere, see anybody and ask any questions. Secondly, there are obvious gaps that need to be filled—for example, the special resolution procedure, where risk is systemic, and an easily understood compensation scheme for depositors. Those should have been put in place years ago; indeed, the Governor wanted them put in place years ago, and it is for the Government of the day to explain why they were not. Thirdly, it is clear to me at the end of this inquiry that the Bank of England should be at the centre of all this. Of course I accept that the Chancellor has to authorise in the last resort the expenditure or commitment of public funds, but I believe that he should do so on the Bank's advice and that the role of the Bank should be paramount. It is the Bank that should have overall supervision of liquidity; it is the Bank that keeps day-to-day watch on the money markets; it is the Bank that should have working knowledge of the bigger banks' operations. That is why I would like to see the Bank of England with its authority restored as a properly independent central bank, not simply the interest rate-setting arm of the Treasury. In the end, it is the Governor—not the Chancellor and not the chairman of the FSA—who should be the ultimate guardian of our financial system. That is why our report proposes new ways to strengthen the Bank's role. Beyond that, there is plenty for the FSA to be getting on with to raise its game: greater emphasis on liquidity management, more transparency and much more rigorous stress testing, as has already been suggested. We may need to look much harder at the whole issue of external validation. It would be fair to say that the Select Committee was unimpressed with the role of the credit rating agencies, which seemed to us hopelessly conflicted. One credit rating agency had taken over £3 million in fees from Northern Rock alone. We also looked hard at the role of the auditors. I do not understand how auditors can give a full, fair and firm opinion but exclude any treatment of the off-balance-sheet vehicles. I find it troubling that Northern Rock's auditor earned nearly three times as much in non-audit fees—in consultancy fees—for arranging the securitisation of Northern Rock's off-balance-sheet vehicles, as it did for the audit, which of course excluded them. I find that troubling. I conclude by raising two wider but related issues. The first is what we mean by financial stability and the systemic risk to it, and the second is the extent to which we can still regard banks as market institutions rather than public utilities. When I posed the first question on Second Reading of the emergency legislation a few weeks ago, I did not get an answer. I think that we need one, however, so let me put it a different way. In the 1970s, the Soviet Union had financial stability and Hong Kong probably did not, but I know which market we would probably all prefer to invest in. Financial stability is something we all say we are in favour of. In Juvenal's great phrase, ““Laudatur et alget””—it is praised, but cold-shouldered. We say we want it, but we certainly are not content with it. We do not expect our bank to deliver it. We do not expect our pension fund to deliver simply stability. We do not expect our investment manager to deliver stability. We expect them, on the contrary, to search continually for better yield in this era of low inflation—to achieve higher than average rates of return, even as inflation disappears globally. Indeed, if something then goes wrong with that search for yield, we do not restrain ourselves from trying to establish, as we heard from the Liberal Democrats, an attempt to prove regulatory failure. If we do not get the yield we expect—if something goes wrong and our investment seems to sink—our constituents will try to secure regulatory failure and then demand a form of compensation. That is why we have to be extremely careful about the concept of financial stability and how we define systemic risk to it. Otherwise, there is no bank, no building society and no investment that can be allowed to fail if enough of our voters are committed to it. At the end of all this, I would prefer a definition of exactly which financial institutions are systemically important. I would like that defined, perhaps by the Bank of England in its financial stability report, but certainly by an authority independent of Government, not by shifting political calculations and emergency meetings of Ministers, so that it is clear to everybody which financial institutions cannot be allowed to fail and which ones still can. The second related question is, what are banks today? Was Northern Rock, for example, really a bank? It had remarkably few depositors. It seemed to me much more of a finance house—a rather poor Tyneside imitation of Morgan Stanley—borrowing money from around the world and betting on future movements of interest rates. To what extent are all our banks and building societies really market institutions? Are they instead public utilities, still dependent on implicit public subsidies when they fail?