Bank feared crash "domino" effect

Wednesday 07 January 2015

Newly-released Bank of England documents today lift the lid on the extent of the credit crunch and banking crash that brought the financial system to its knees and sparked the worst recession since the war.

The Bank has published minutes of its Court meetings from 2007-9 covering its response to the collapses of Northern Rock and Royal Bank of Scotland as it held emergency meetings using secret code words to discuss the crisis.

They reveal the unprecedented measures taken by Threadneedle Street officials to stave off the disaster and how the enormity of the crisis tested its powers as "lender of last resort" - standing behind the UK economy - to the limit. The Court was asked to grant the Governor Mervyn King powers to make secret emergency funding available to troubled lenders.

But its own balance sheet was stretched to such an extent by propping up the financial system that it considered asking for a "significant capital injection" from the Treasury - though it is understood that in the event this was not needed.

The minutes disclose how the Bank feared a "domino" effect from the implosion of Northern Rock in 2007 but that measures taken to revive financial markets frozen by the credit crunch at that time were to prove merely a "sticking plaster".

A year later in October 2008, RBS was also on the brink and facing a 36 billion US dollar (£24 billion) black hole when it came cap in hand to the Bank, having already tapped up the European Central Bank and US Federal Reserve.

The bank asked for a 20 billion US dollar (£13 billion) credit line - only to return two days later needing an extra 5-10 billion US dollars (£3-7 billion) to tide it over until the weekend.

Highly sensitive and short notice decisions were taken by an emergency sub-committee known as Transco that met 11 times during the crisis and used code words such as Phoenix for RBS and Lark for Lloyds TSB. Other lenders were referred to as Badger (Bradford and Bingley), Fox (Halifax Bank of Scotland) and Tiger (Alliance and Leicester).

Ultimately the Government stepped in with a series of bail-outs including the £45 billion rescue of RBS and £20 billion lifeline for Lloyds. At the time, the minutes reveal, Bank insiders expected the Treasury to hold on to chunks of the lenders for between six months and six years. More than six years later, the process of disposing of Lloyds has begun though more than a fifth still belongs to the state while RBS remains 80% owned by the taxpayer with the prospect of a return to private ownership continuing to be a distant prospect.

Yet a year before RBS's collapse, the minutes revealed, the chairman of the Financial Services Authority (FSA) regulator - who at the time was Callum McCarthy - had said that the "UK banking system was sound".

Andrew Tyrie, chairman of the Commons Treasury select committee, said the minutes showed little evidence that the Court - the Bank of England's oversight committee - provided effective challenge to the governor and his executive team.

Mr Tyrie said: "The minutes show that during the crisis the Bank of England did not have a board worthy of the name."

He said they showed the need for the "radical and welcome reforms" to the Bank's structure that were announced last month.

Mr Tyrie also criticised the committee's response in September 2007 when it "accepted and applauded" the governor's view on the risk of "moral hazard" - that is, that bail-outs could encourage future risk-taking.

His remarks during the credit crunch came a day before it emerged that Northern Rock had called in emergency funding from the Bank of England, described in the minutes as a "the most significant lender of last resort facility" since the 1970s.

Directors of Court were understood not to have been told about the move until the last minute - when details were leaked to the BBC - due to conflicts of interest stemming from their non-Bank roles. The minutes revealed fears that the lender's collapse could spark a "domino effect", first hitting building societies with holdings in the firm, then putting three other unnamed institutions with similar business models in a "more precarious position". They also revealed that rules on transparency requiring disclosure of its help to lenders in trouble effectively "nullified" the Bank's position as "lender of last resort".

Bank officials told the Court that they were "equipped with sufficient tools to manage the situation if a limited number of institutions had difficulties but a wider problem would be difficult to manage".

Directors were asked to give the governor powers to grant extra funding to lenders "through a range of possible covert mechanisms" without consulting them.

Meanwhile queues outside Northern Rock as customers tried to withdraw deposits were dispersed after a pledge by Chancellor Alistair Darling to guarantee savings.

But the minutes revealed that by October, as wholesale funds continued to be withdrawn, it was 48 hours from exhausting its emergency credit line prompting the Treasury to beef up its support and asking the Bank to increase its facility. The lender was later nationalised.

By October 2008, the crisis had deepened following the collapse of Lehman Brothers as inter-bank lending seized up, prompting the Government to step in to bail out troubled banks. By this stage officials believed the worst was over after they had helped to bring about the announcements of the Government's "recapitalisation plan".

"There was now a real sense that a corner had been turned and the Bank could be proud of its work and contribution," the minutes said.

Yet they showed that the Bank of England had previously come within a whisker of acting effectively to replace money markets itself - a move that carried its own risks of freezing up the system.

Publishing the documents today, the Bank acknowledged that at the time of the crisis, the Court had been hampered by deficiencies including its large size and conflicts of interest of its members.

The Bank also lacked powers to take action on general risks to the economy and there was no specific body ready to step in to "resolve" failing banks with the roles of Threadneedle Street, the Treasury and the FSA during a crisis ill-defined.

Current governor Mark Carney said: "The financial crisis was a turning point in the Bank's history.

"The minutes provide further insight into the Bank's actions during this exceptional period - the policies implemented to mitigate the crisis, the lessons that were learned, and how the Bank changed as a result."