HECTOR SANTS, the chief executive of the Financial Services Authority (FSA),
called his most senior lieutenants to a crisis meeting on August 10 last
year.
A day earlier, the credit markets had frozen. It was already clear that
Northern Rock was in trouble, yet nobody at the regulator had been expecting
it.
Sants had taken over as the FSA’s chief executive a few days earlier. It was
the first time he had been responsible for regulating the nation’s
high-street banks.
He immediately ordered a review of bank regulation to find out if any other
institutions were in trouble. Teams of FSA staff were sent to every bank in
the country to find out if they faced similar problems. It has been in daily
contact with every institution in the country ever since.
Yet it was only last week that the extent of the regulator’s incompetence in
relation to Northern Rock was laid bare. A damning internal report by the
FSA into the events that led up to Northern Rock’s crisis revealed a litany
of errors.
Senior regulators did not even bother to meet Northern Rock or question its
behaviour. Although there were concerns, nobody acted on them.
Sants is beginning his fight-back by trying to assemble a team of former
senior bankers to form an advisory panel that will help to restore the
regulator’s credibility.
“Sants has to demonstrate that the organisation and its senior management are
still fit for purpose,” said John McFall MP, chairman of the Treasury select
committee.
Within the FSA, sources say the most shocking element of last week’s report
was that no member of the regulator’s senior staff was in contact with
Northern Rock in the run-up to the bank’s collapse. That failing can be
traced back to a decision taken at an FSA meeting on February 20, 2006.
Every financial institution in the country is monitored by a so-called Arrow
panel, comprised of an assortment of mid-ranking executives from within the
watchdog’s empire. It’s where the regulators are regulated.
The team responsible for handling Northern Rock’s day-to-day supervision
recommended that the bank should be subjected to a full-scale Arrow review
every 24 months. It was a slightly more lenient regime than most banks have
to comply with, but seemed fitting at the time.
The panel had a different view. At the time, the FSA was trying to be seen
cutting red tape for the industry. Arrow reviews were a particular bone of
contention.
As a gesture of goodwill, the Northern Rock panel overruled its on-the-ground
staff and decreed that the Rock would be placed under the microscope only
once every three years.
“The guys supervising Northern Rock were overruled,” said Ian Mason, partner
at the law firm Barlow Lyde & Gilbert and a former head of department in
the enforcement division of the FSA. “The people that were supposed to be
challenging the decisions taken adopted a more lenient stance than the guys
who knew Northern Rock’s business.”
Running parallel to these discussions, Northern Rock was engaged in
discussions with the FSA about how new European rules could be used to
release cash from its balance sheet.
The Basel II regime was destined to be favourable to mortgage banks. Analysts
thought that Northern Rock might be able to free up 30% of its capital.
In the end, weeks before the bank hit trouble, Adam Apple-garth, Northern
Rock’s chief executive, struck a deal with the regulators that he said would
pave the way for “huge increases in dividends and share buybacks”.
Last week’s report revealed there were 10 meetings between Northern Rock and
the FSA to discuss freeing up capital between January 1, 2005, and August 9,
2007.
The other meetings to discuss funding risks and potential problems in the
business never really happened. Of seven meetings, five took place on one
day. Two of the meetings were conducted on the phone. And the regulatory
probe could uncover typed minutes for only one of the seven meetings.
Previous gaffes by the regulator - such as its handling of Equitable Life -
have been of a different nature. In those situations, FSA officials crawled
all over everything but simply made bad decisions. In this instance, the
regulator did not even challenge Northern Rock on any of the contentious
points.
“If you are supposed to be playing in a football match, people can reasonably
expect you to be on the pitch,” said one source close to the regulator. “We
weren’t even on the pitch.”
It was the wrong group of people doing the job in any case. Between January
2005 and June 2006, Northern Rock’s regulation was being handled by a
division of the regulator tasked primarily with monitoring insurers. It was
only in February 2007 that it began to be regulated by the same people who
were monitoring Britain’s high-street banks.
In its defence, the FSA says its regulatory regime is “not designed to ensure
that any given institution cannot fail”. Even if Northern Rock had been
subjected to a thorough regulatory examination, that would not have prepared
the bank for the total collapse of the credit markets that ultimately
brought it to its knees.
“They are quite right to say that,” said Angela Knight, chief executive of the
British Bankers’ Association. “But that’s not quite the whole story. They
could have made Northern Rock find other lines of liquidity; there could
have been limits placed on their ability to write new business until those
concerns were addressed.
“That would have all been very uncomfortable for Northern Rock but it could
have prevented the catastrophe that followed,” she said.
All the people who were involved in the supervision of Northern Rock have now
been sidelined or ousted from the regulator altogether.
Heads have already rolled at the FSA. Clive Briault, head of the FSA’s retail
division - which was responsible for monitoring Northern Rock - is to leave
the regulator “by mutual consent” next month. He is thought to be in line
for a £400,000 payoff.
David Strachan, the regulator’s director of Major Retail Groups, has had
banking supervision stripped from his remit. He will now focus on financial
stability.
Questions are also being asked as to why Briault lumbered Strachan with such a
cumbersome brief in the first place.
Sants has pledged to hire 100 new supervisors to help tackle the problems. The
only question now is how he can afford to offer salaries that will lure the
right people out of the big banks to do the job.
“The FSA is going to find it difficult to recruit 100 new supervisors of the
calibre required to do this job,” said Mason. “These are the real rocket
scientists – exactly the people the banks want themselves.
“Now the FSA has made it clear that it is going to really be kicking the tyres
on this type of issue, it is going to find it hard to compete for people.”
McFall has a different suggestion. He wants to see more bankers forced to work
on second-ment to the regulator.
“There has to be a way to ensure that the flow of people is not exclusively
out of the FSA into the private sector,” he said. “There is an
industry-second-ment programme already, but I think that needs to be stepped
up substantially.”
Sants has already drafted a number of former bankers into the wholesale side
of the FSA’s operations – the division that he ran before moving up into the
top job.
He is known to be attempting to recruit externally to find Briault’s
replacement. It seems that ensuring there is no repeat of the Northern Rock
crisis will require big hitters – on big salaries.
I read that Sir Derek Wanless was the Director and Chairman of Risk Committee at the beleagured Northern Rock. Wanless is a former CEO of NatWest, Gordon Brown's esteemed and "intellectual" friend, and a Member of the Board of Actuaries. Presumably, the FSA thought he was a safe pair of hands ? Gordon Brown did likewise when he commissioned Wanless to write the 2002 NHS Funding Report ?? Give the FSA a break, they were just the long stop. Instead, ask Wanless why he was not doing his job !
John, Hereford, UK