The most serious issue that the Enquiry into the Bank should raise is its role in the collapses of Northern Rock and RBS. We have seen that it failed to influence the tripartite regulators into controlling the surge in bank balance sheets in the years of expansion. In the two years of collapse it failed to make enough liquidity available in time to avoid a run on one bank and a near cessation of trading at another.
One of the prime tasks of a Central Bank is to be the lender of last resort to banks in its system. All banks are meant to be solvent. The banking regulator supervises them and certifies they are. The Central Bank has to ensure they are also liquid. A strong bank may have a lot of its money invested in high grade loans. If too many depositors want their deposits out at the same time it may not have the cash to pay them. Given time it can sell its loans on to someone else and free the cash. The Central Bank is meant to step in and lend to bridge the gap.
In the torrid banking summer of 2007 some of us were urging the Bank of England to make the banking markets more liquid by injecting cash into the system. The Bank refused. The inter bank markets dried up as banks lost confidence in each other. Northern Rock depended on a lot of inter bank borrowing to support its large mortgage business. It was obviously at risk. The Bank of England argued that it would induce moral hazard if it lent more to Northern Rock or other banks short of liquidity. The result became well advertised when Northern Rock ran out of cash.
After the collapse of the Rock the Bank of England did inject more liquidity into the system, showing it could do so. It repeated this performance on a larger scale with RBS a year later.
The Review needs to ask why didn’t the Bank act as a lender of last resort to a greater extent earlier to ward off bank collapses? Wouldn’t it have been better if the Bank had made cash available to prevent these collapses? Wouldn’t short term loans have been cheaper and better for taxpayers than forced purchase of shares? Wouldn’t such action have staved off the worst but forced the banks to cut costs and sell assets to repay the loans? Isn’t that the new system they say they now wish to operate in a future crisis?Why didn’t they do it when they had a live crisis? If living wills are good for a future crisis, why didn’t they use a controlled form of administration, where the authorities kept the main deposits and payment systems going?