What are the lessons of Northern Rock?

There are two tired and overworked phrases in this governments repertoire which we are about to hear concerning Northern Rock.

The first is ??We have learned the lessons?? of whatever catastrophe they are talking about.

The second is: ??We will make sure this will never happen again??.

Ministers usually recite these phrases instead of providing proper analysis of what went wrong, and in place of ensuring the people in whatever regulatory system they have are up to the job and empowered to make the right decisions in good time.

I remember when I was the DTI Minister responsible for financial regulation, in the days when the DTI regulated insurance and financial services itself, having to handle the occasional problem. Each time the cry would go up to change the law and regulation. I usually pointed out that what had happened was a breach of the law or regulation anyway. We werent short of laws even then and there are many more now. It was intelligent enforcement that had failed. I was also pressed to guarantee it would never happen again. I was usually careful to make no such guarantee, and to point out that in any field of human endeavour there will always be some mistakes and some lawbreakers.

This government is foolish to say there will never be another loss of data by the public sector, because there will be. They should claim instead it is much less likely. They do have to be able to say there will never be another run on a bank, as we know we can have a period of more than a hundred years without one. Something uniquely wrong has happened on their watch.

My concern with Northern Rock is that the government does not appear to have learned the lessons. It is usually wise to manage a crisis to a conclusion before attempting to learn all the lessons. This crisis is far from over. Where there is a need for earlier action ?? as there may be on a deposit guarantee scheme ?? it needs to be carried out as an interim response, not foreclosing other action to mend the regulatory system once the crisis has been resolved or is stable.

What are the lessons of Northern Rock?

It is unwise for a Chancellor and Bank Governor to lecture the banking system about the need to deal with their own banking mistakes without assistance from the authorities, just a few days before offering massive assistance on a scale never before seen in the UK. If the authorities know of an institution in trouble ?? as they did a month before the run on the Rock ?? they should avoid inflammatory statements that they might have to rescind.

It is unwise to keep the banking system starved of cash until a major institution is in deep difficulties, and then to provide money to the system after a run on a bank has begun. If money is going to be provided, it should be provided early.

A tripartite structure for responding to a banking crisis is too inflexible, and keeps the Bank starved of important hour by hour information on the state of banking markets. There should be a unified command under the Bank of England. The Bank should have to keep the Chancellor informed, and submit to his judgement if things become out of hand. The Bank needs to get back the management of government debt, and day to day banking supervision, as it had before the Brown reforms.

The Basel I capital rules did not work as intended, and Basel II may now make matters worse. The government should enter discussions with the international community about a sensible capital adequacy regime, which gives enough attention to liquidity, and which deals differently with off balance sheet items.

The world authorities should avoid seeking to increase the capital requirements rapidly at a time of banking risk aversion. Any necessary increase in banking capital requirements should be phased in, as the system stabilises and starts to function more aggressively. IT will make matters worse if we hear the sound of regulators slamming the doors on capital adequacy after the horse has bolted, against a background of damaged balance sheets and a reluctance to lend.

The government should consider changes to allow take-overs of banks in trouble to take place rapidly, with the negotiations happening in private. This may well entail changing or clarifying EU law. This should be carried out urgently.

The government has asked the private sector to come up with a better deposit guarantee scheme. This should be put into effect promptly. More importantly,. The government should work out how to climb down from its blanket guarantee of all bank deposits in the UK of any bank in trouble without triggering a further run, seeking to do this in parallel with the changes to the overall guarantee system.