11October 2007
Northern Rock PLC
Mr Speaker, with permission, I would like to make a statement on Northern Rock plc.
As I said in my written statement on Monday, Northern Rock got into difficulty following the problems triggered in the US mortgage market, but which have gone on to affect the financial markets in countries all around the world.
In early August , when the markets realised the extent of the problems in the US sub-prime market, they also began to have doubts about the value of other asset backed securities. Uncertainty over which institutions were exposed and to what extent, meant institutions lent to each other at much higher rates, and in some cases stopped lending to each other altogether.
The result: a large reduction of money in the market generally and an increase in the cost of borrowing, not just for those with exposure to sub prime mortgages but for all institutions.
These developments have had global impact, affecting major US mortgage lenders, a major French bank and banks in Germany.
The availability of credit has increased the last few weeks, so we can be more confident, but we cannot be certain when the current instability will end.
Britain entered the global turbulence with a stable economy, and a strong banking sector that has experienced rapid growth with well-capitalised balance sheets. British institutions have less direct exposure to sub-prime assets, and our sub prime market share, 5 per cent, is much lower that of the US.
However, Northern Rock, because of its business model, faced particular problems: it has a large share of Britain's mortgages, but they are primarily financed through the wholesale markets, including a significant proportion from securitisation. This meant Northern Rock was particularly vulnerable to the virtual closing of this market over the summer.
On 14 August the FSA told the Bank and the Treasury about their concerns on Northern Rock and its vulnerability in the current market circumstances. During August it became increasingly clear that Northern Rock was having difficulty getting access to the financing it needed, and that the cost of doing so was increasing.
The general situation and Northern Rock's position in particular were monitored on a daily basis. On 5 September the Bank announced £4 billion of extra support to provide increased liquidity to the wider market. As Northern Rock's position deteriorated, it became clear that specific support was likely to be needed for it.
On the 13 September the Governor and the Chairman of the FSA recommended that I authorise the Bank to provide special liquidity support and I agreed because I believed this was justified.
There are clear principles governing such support, which are set out in the memorandum of understanding, between the Treasury, Bank and FSA, first signed in 1997: such support should only be undertaken where there is a genuine threat to the stability of the financial system and in order to avoid a serious disturbance in the wider economy. That was the case here.
The provision of this support was announced on the 14 September. Although the FSA had assured the public that Northern Rock was solvent and that if depositors wanted to get their money out they could do so, it became clear that further assurance was needed.
So on 17 September, again on the advice and with the agreement of the FSA and Bank of England, I announced that during the current instability in the financial markets and should it prove necessary, I would put in place arrangements that would guarantee all the existing deposits in Northern Rock. This undertaking was explained and extended on 20 and 21 September.
The Treasury, Bank and FSA continue to work intensively with Northern Rock with a view to helping it resolve the situation. Any future solution must lie with the company. The Government have provided appropriate help and we will continue to do so. As I reported to the House on Tuesday, I have extended the Government's guarantee arrangements to all new retail deposits for which Northern Rock will pay a fee, while the Bank has provided an additional loan facility, which replaced that of the lender of last resort. I have today written to the Chairman of the Treasury Select and Public Accounts Committee setting out more details, and I am publishing this letter and placing a copy in the library of the House.
There are clearly lessons to be learnt from what happened to Northern Rock and the wider instability across the world.
Mr Speaker, the responsibility to minimise risks and prevent problems happening in a particular bank lies, first and foremost, with the directors acting on behalf of its shareholders. That is their clear duty.
It is the job of the financial authorities to set the policy and regulatory framework in which institutions and markets work.
Let me remind the House of the responsibilities here:
- as the House knows, the Bank of England has complete independence in monetary policy; its second core purpose is financial Stability, a role it discharges on a daily basis;
- the FSA, also independent, is responsible for the supervision of individual firms, like Northern Rock;
- and because of the importance of the financial system for the stability of the economy as a whole - and the potential impact on the Exchequer in ensuring that stability - the Government is rightly also involved: the Treasury is responsible for the overall legislative framework and I am accountable to Parliament.
I believe it is right the Bank and FSA should continue with those responsibilities. This is a model others around the world are now following. But we do need to review how the framework has operated and put in place whatever practical improvements are needed.
As the FSA has said, it is reviewing for itself its own lessons. And I look forward to their conclusions early next year.
We need to make more reforms to prevent problems happening internationally and in Britain.
First, when the Financial Stability Forum reports at the G7 to Finance Ministers in Washington next week I will urge faster rapid implementation of international agreements on solvency; accelerated work on international standards for regulating liquidity; more transparent information on credit ratings; and action to improve the transparency of off-balance sheet vehicles.
Second, I will propose an IMF and FSF early warning system to strengthen financial sector surveillance, identify risks to stability, coordinated regulatory responses to them.
And third, I can report European agreement this week to strengthen arrangements for ensuring financial stability in Europe and increased cross border management.
It is important regulators focus on liquidity as well solvency. Here at home, the FSA will shortly set out proposals for a review of the UK liquidity regime.
As the Governor has said, all central banks face problems in providing support to banks in difficulty in a world where markets rightly expect high levels of disclosure and transparency. So I can confirm that if it proves necessary to clarify in Europe the legal and practical issues surrounding the way in which such support is provided and disclosed to protect financial stability, we will work with other European countries to provide that certainty. And we will now review whether rules about the swift takeovers of banks need to be changed.
But when problems do occur, we need to have a system in place that is clear and reassures depositors.
We will introduce legislation in the next session to establish a new regime.
Today - with the FSA and the Bank - I am proposing in a discussion document published today the principles for this new regime.
This new regime would mean: depositors are insulated from a bank that has failed, greater compensation for them, and certainty their compensation can be paid out quickly.
As a first stage the FSA has decided that Financial Services Compensation Scheme is now covering 100 per cent of deposits up to £35,000. But I have made clear this is just an initial step towards a more comprehensive change.
We will work closely with the banking industry, consumer groups and others to agree this new regime. And I hope there will be cross party consensus on it.
We must all - internationally and domestically - consider what lessons there are to learn from the summer's events, and if needed, I will take action.
The changes we will make will strengthen, our reputation as the world's leading international financial centre, and be founded on our commitment to maintain a strong and stable economy.
I commend this statement to the House.
Ends