Sep 21 2007
The end of the Bank’s road for Lender of last resort?
Yesterday the Goveernor of the Bank of England stated that he would like to have lent money to Northern Rock without making it public, but had been unable to do so owing to the legal position established by the Market Abuses Directive.
Some say the Market Abuses Directive would have allowed confidential lending in these circumstances, but clearly that was not the view of the UK authorities who presumably took legal advice on the matter given how important it was.
This seems to mean the Bank can no longer act as "Lender of last Resort" in troubled circumstances to a bank, as the announcement it was doing so helped generate the queues of depositors wanting their money out of the Northern Rock.
This invites a number of crucial questions to the Chancellor and the UK monetary authorities:
1. Why did no-one realise when the Market Abuses Directive was negotiated that this could be a problem? Why didn’t the UK insist on a clear opt out for the Lender of Last resort activity?
2. Does this mean that in future the Lender of Last resort facility, if used, will have to be used with a Treasury guarantee on all deposits, as proved necessary in the end with Northern Rock?
3. When is the UK government going to propose a suitable amendment to the Directive so that confidentiality can be used when appropriate?
Some people think that more transparency is the answer to this problem. As someone who usually favours more open reporting and the free exchange of informaiton, I do think the opposite is the case in this sensitive area.
If a company other than a bank discovers that its usual bank will not offer it the size of loan it needs to carry on trading, but it can get a loan that is sufficient from another source, it does not have to make public statements about this. Loan negotiations for heavily borrowed companies can be difficult, and they are best done by those who need to know away from the glare of publicity. Directors know that they must not carry on trading if they do not have access to sufficient money to cover their bills for the following year, and know there will be an independent audit of this annually.
The same should be true for a bank. The fact that a bank may use the Bank of England, the bankers’ bank, as the source of its temporary cash needs, does not make this different in kind. If the business is solvent, and it so happens that it needs to use the Bank of England’s facility at a particular time, it should be allowed to do so without a special announcement to the markets.
So what should the government do now?
1. Check the legal advice of the Bank over the question of disclosing the use of the Lending facility
2. Help the Bank explain that offering money to banks as Lender of Last resort is not a "bail out" but a commercial transaction where the banks have to repay with interest. It has always been part of our system that the Bank of England has to supply cash to the market as apppropriate, and has a monopoly over banknote issue which the other banks need as till money.
3. If the Market Abuses Directive does prevent confidentiality, table proposals urgently in Brussels to amend it
4. If changes are needed in UK law or can be made via UK law, table those urgently
5. Work with the Bank to restore normal conditions in money markets so it can cancel its taxpayers guarantee on deposits as quickly as possible.
If the government does not do this, it appears that we have just lost another function of an "independent Central bank", the function to act as lender of last resort to the banking system in an effective way.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
[...] unknown wrote an interesting post today onHere’s a quick excerptYesterday the Goveernor of the Bank of England stated that he would like to have lent money to Northern Rock without making it public, but had been unable to do so owing to the legal position established by the Market Abuses Directive. … [...]
It’s quite clear that the line between the government and the BoE has become very blurry in terms of what they expect from each other and who is responsible for certain situations. Your proposals seem reasonable and would help to address this problem, but somehow Labour have got away with demonstrating their incompetence yet again.
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This fiasco seems to illustrate a serious democratic deficit, namely the failure of Parliament to hold Ministers to account with regards to EU Directives.
The Market Abuse Directive did not simply appear out of thin air - it was subject to consultation and drafting - both in it’s creation and its implementation in the UK (as is evident from documents on the Treasury and FSA websites).
So why did Parliament fail to subject it to proper scrutiny? Was appropriate legal advice sought and considered before it was implemented and if not why not?
Reply: Yes there is a serious problem. Parliament needs to be consulted and to debate these Directives BEFORE they are agreed to in Brussels, not after the event. We also need more than one and half hours for a complex Statutory Instrument presented on a take it or leave it basis. We need the opportunity to amend them. I am pressing for all these changes.
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Some people think that more transparency is the answer to this problem. As someone who usually favours more open reporting and the free exchange of informaiton, I do think the opposite is the case in this sensitive area.
I think that’s absolutely correct. As far as I can see, the announcement that Northern Rock had contacted the BoE was not only unnecessary, but was the cause of the “crises” and nearly led to the Northern Rock collapsing simply because of all the savers taking their money out. Not only was the Northern Rock in no danger of collapse (before the announcement) with access to the lender of last resort facility, it hadn’t even needed to use to facility–it was merely being prudent by securing the possibility. So, the NR’s customers and shareholders didn’t really need to know it had sought access to lender of last resort, and by making this information public both groups stood to lose out due to a run on the bank.
This needs to be addressed as quickly as possible, because the current situation may be sowing the seeds of a future crises. For example, will banks now be reluctant to request the lender of last resort facility if they get into difficulties? If so, there is much more chance of a bank collapsing in a credit crunch such as we are in today. Similarly, if the government is now guaranteeing all deposits, it seems likely that banks will become much less prudent in years to come, as customers demand a better return without caring if the bank is likely to collapse. Where will it end–a Nationalized banking system?
Reply: please see today’s blog item on the lender of last resort.
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John, you are right to say that some business is better done in a calm atmosphere and behind closed doors. Would a future Conservative government be willing to re-set conditions for the BOE to operate in away that causes the least turbulence to the market?
Reply: That’s what I want them to say and do.
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Dunsaving: “So why did Parliament fail to subject it to proper scrutiny? Was appropriate legal advice sought and considered before it was implemented and if not why not?”
This illustrates a common misconception about European Directives, once they arrive in Parliament they are not really open to negotiation. They are in fact DIRECTIVES.
Given that the UK has the biggest financial market in the EU, in deciding on an initiative like “The Market Abuse Directive” we are always going to be in a minority of one, there would need to be some serious horse trading - since the government has given pretty much everything else away there is almost nothing to trade. So we get instructed to do things that are against the interests of the United Kingdom population. The people who implement these regulations in to UK Law are the very people who are supposed to be representing our interests in Parliament, they are taking our money and failing to do the job.
Reply: (Reference to a particular banking executive removed) There is a clear need for a government which highlights these difficulties before a Directive is agreed, and if necessary digs in and refuses to implement it in the UK if the others want to push through something that does damage. Parliament cannot stop a Directive passing into UK law where the UK government wants to push it through, has already conceded in Brussels and has a majority - I know because I have tried to stop things under this government.
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The Market Abuse Directive is no different to the one signed to cut CFC’s, or the one to allow wholesale immigration. Quite simply, this government is in such a hurry to show that it is a good European, that it will sing anything without looking at the big, let alone the small print. That is why we had mountains of fridges that we did not know what to do with. That is why we have senior police officers crying out for more fundis to deal with the rising crime way caused by immigrants from Eastern Europe. That is why our public services, Education, and the NHS is struggling, because no one thought about the consequences.
Reply: Yes, one of the least told stories under this government is the unwillingness to engage in serious negotiaiton to stem the flood of ill thought out and damaging directives from Brussels.
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JR: It
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Are you seriously suggesting that a bailout of a bank that’s got in a mess should be kept a secret? Or that an EU rule that stops it being kept a secret is in some way a bad thing? If the law against stealing had come from Brussels would you be against that as well? You are barking mad. This is why the conservative party can’t get elected.
Reply: NO I am not proposing any bail out. A bank that is involvent should go down without public assistance. If a bank needs to borrow from its bank, the Bank of England, that should take place in private as most other bank loans do. Trading companies do not have to publish details of their latest bank loan.
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JR:
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Northern Rock is frankly only the first crack in the system- a busted system which has allowed in the words of the FT’s chief economist and notable bilderberger Mr. Martin Wolf “grotesque lending practices” to evolve. The system of fractional reserve lending in which bankers may create money out of thin air , derivatise that debt, bundle it up into complex products such as CDO’s , persuade their mates at moodies to rate their toxic waste as AAA and then sell it to japanese school teachers pension funds as a gilt edged income stream is indeed grotesque. More grotesque when one hears that city bonus’ topped 14 billion last year. More grotesque still when one considers what banks have and are doing. In 1970 it was only possible to borrow one times the principle wage earners salary as a mortgage on a house, that ensured that when young ladies became mums they weren’t responsible for servicing debt, banks creatively and progressively loosened those lending criteria until multiples of up to 6 times double incomes were offered, ensuring that property remained constantly inflating and women remained debt servants (slaves) throughout their lives, ensuring that children are brought up in stressed out skint households without a mother who is too busy paying the interest on the banksters debts. Once all the women were so far in they could no longer properly care for their children and society was creaking at the seams, they found their next target, children! ! “cheap student loans” were invented , as an employer I have new mums weeping in front of me regularly pleading for part time work because they need to continue paying the mortgage , and I get job applicants arriving from university with 20k of debt around their necks. John….you are part of this game, stand up and demand monetary reform and I will cease to believe the conspiracy theorists who claim you are all pawns of the Rothschilds.
Reply: I am not a Director of any bank let alone Rothschilds - who incidentally are not in the mortgage market as I understand it.
I agree that some institutions have been lending high multiples of salary, and this has driven house prices higher - something ignored in the first Barker report and in this government’s view of the housing market. Higher inetrest rates are stopping that - it was the product of the Bank and government keeping interest artes so low for so long.
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Glad to see someone is staying on top of things.
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