SIR CALLUM MCCARTHY, MR HECTOR SANTS AND MS MARGARET COLE

6 MAY 2008

  Q20  Mr Fallon: But the ones you have kept have simply been shuffled sideways have they?

  Sir Callum McCarthy: Some of them have been moved.

  Q21  Mr Fallon: They have been shuffled sideways?

  Sir Callum McCarthy: Some of them have been moved. They have been moved out of direct supervisory responsibility.

  Q22  Mr Fallon: So they have failed at supervision but they are still being kept on the books doing something else?

  Sir Callum McCarthy: There are people who have been moved to other places where we believe that they should remain as employees of the FSA. If we had not been of that judgment they would have left the FSA.

  Q23  Mr Fallon: How many senior managers were paid bonuses in the year 2007-08?

  Sir Callum McCarthy: It is a question I would be grateful if the Chief Executive could answer because I am not sure I know the answer. Most managers in the FSA, indeed all staff in the FSA, qualify for bonuses. I do not know how many senior managers in total.

  Mr Sants: It would depend on how you chose to define "senior managers" but I assume the question you are asking is about non-Board members of the FSA and were they paid bonuses in the period in question, and the answer is yes.

  Q24  Mr Fallon: The bonus information for senior manager is not in your annual report, it is only there for the directors.

  Mr Sants: Is that the question you are asking, whether or not we list individual bonuses for non-directors in the annual report? That would not be normal practice.

  Q25  Mr Fallon: The question is how many senior managers received bonuses in 2007-08 and how does that compare with the previous year?

  Mr Sants: I was saying if you would like to define to me how you want me to define senior managers, whether you wish me to define them as directors or heads of department or the total pool, then I will happily answer the question. Perhaps I could put it in witting back to you.[1]

  Q26 Mr Fallon: Did you pay more in bonuses in the financial year just concluded than you did in the previous financial year?

  Mr Sants: Again, it is a matter for the Board's decision but we paid the same percentage of bonuses to the employees of the FSA for 2007-08 as we did in the previous year.

  Q27  Mr Fallon: Percentage of what, total remuneration?

  Mr Sants: Of salaries, yes, that is the way we look at it.

  Q28  Mr Fallon: Not of people but of total remuneration?

  Mr Sants: Yes, the bonus percentage of their salaries across the whole of the FSA was the same for the two years in question. It was a decision that was made by the Board on the recommendation of the executive and was reflective of the excellent work across the entire organisation and the executive thought that was a fair recommendation to make to the Board, which was accepted.

  Q29  Mr Fallon: You have shuffled a lot of these people sideways because they have failed and you have hired 100 new supervisors. How can you give us confidence that the 100 new supervisors will be better than the last lot?

  Mr Sants: We have not completed the hiring programme. We have indicated our intention to increase significantly the number of supervisors, a number of whom have been hired. In terms of ensuring that the quality is at a level we require going forward, one of the measures we are taking is to further improve and tighten our overall training and competency regime. We will have higher standards to be achieved for supervisors and a tighter regime to ensure that those competences have been achieved and if they do not achieve those competences they will not continue as supervisors.

  Q30  Mr Fallon: Does that mean they are being employed on shorter contracts than previously?

  Mr Sants: We do not use contracts in the way I think you are implying. People are employed in the FSA as they are in all normal organisations. What I am saying is if they do not achieve the required level of competency, ie do not achieve the qualifications we require in order to be a supervisor, they will not be allowed to continue in supervision. This is a change from where the FSA was before. Going forward, we will have a formal competency requirement with testing for supervision.

  Q31  Mr Fallon: Sir Callum, do you not think it would have been an acknowledgement of the extent to which you recognise the failure of supervision of Northern Rock and the confidence you want to give everybody in claiming these new powers if at least one person had been dismissed? Out of 2,600 people not one has been sacked.

  Sir Callum McCarthy: There have been various people who have left the FSA. Some have left by mutual agreement. There have been a number of people who have been moved and I think that if some people had not earlier left we would also have had more people who would have left by mutual agreement.

  Q32  Peter Viggers: The internal audit says that the FSA was operating prior to August 2007 with a presumption that "in the event of a crisis like that experienced in August 2007, general market liquidity provided by the Bank of England would be increased and, in extremis, liquidity would be provided for systemically important institutions." Is that a fair summary of the FSA's attitude at that time?

  Sir Callum McCarthy: Yes it is.

  Q33  Peter Viggers: Why did such a seemingly dangerous mismatch between the expectations of two of the members of the Tripartite Authorities exist, because that was not the way the Bank of England saw it, was it?

  Sir Callum McCarthy: If you look at the provision of liquidity to a solvent institution, which was what happened in relation to Northern Rock, liquidity was provided by the Bank of England. The problem in relation to Northern Rock is that the actual use of a weapon that has always been part of the armoury of central banks and of supervisors, namely the provision of liquidity to an institution that was solvent, instead of having the effect of giving confidence, had exactly the opposite effect. I do not think the problem was the refusal of the Bank of England to provide liquidity, because after all that is what happened; the problem was that when that liquidity was provided, it actually triggered the retail run that undid Northern Rock.

  Q34  Peter Viggers: Did the presumption about the provision of liquidity affect the way in which you regulated liquidity?

  Sir Callum McCarthy: In one respect yes, because the sterling regime that we have, which is the quantified aspect of our liquidity regime rather than more qualitative aspects, essentially is a regime which presupposes that if there is a catastrophic failure and a problem institutions will have a short buffer of liquidity until the central bank actually takes action, and that is something that is well established and has been there for years. Incidentally, it is a quantitative measure which Northern Rock comfortably exceeded so that was not the problem.

  Q35  Peter Viggers: One of your responses to the internal audit is to seek to improve working level relations with the Financial Stability Directorate at the Bank of England. How are you going about implementing such improvements and what are the results that you wish to see?

  Sir Callum McCarthy: I think that one of the things that the Governor made clear when he gave evidence to you was that he regarded the involvement of the Bank in relation to Northern Rock as having happened rather late in the day. There is nothing institutional in the arrangements that prevented that happening. The Governor for example saw the then Chairman of Northern Rock on exactly the same day that Hector and I saw the Chairman of Northern Rock, which happened to be 30 August, considerably in advance of the point at which liquidity was actually announced. I think there are some important questions in terms of the detailed working arrangements between the Bank and FSA to make sure that in future if there were ever to be a case comparable to Northern Rock the Bank is encouraged to raise all questions that it wants to raise about the actual eligible collateral assets, et cetera, of the institution at an early stage, and those are things which are being worked on as the Governor's evidence made clear.

  Mr Sants: I think you are also asking about improvements going forward. We are also putting in place an improved technology platform so effectively in the future our vision would be that the Bank officials would have the same access to data as if they were sitting in the FSA, ie everybody working off the same database. We would obviously be obtaining the data from the institutions to simplify that data collection process but effectively it will become, in virtual terms, a single department.

  Q36  Peter Viggers: I think it is common ground that in the case of extreme difficulty it will be the Bank of England that will step in and deal with the administration of the bank because only the Bank of England has the financial levers available. The point of dispute which I think colleagues would agree is the thrust of our report on the run on the Rock is that the Bank of England should remain sufficiently close to the situation overall so that it can, if it feels appropriate, trigger the special arrangements. I take it from answers to previous questions that you do not accept that and you feel that this must be something entirely within the purview of the FSA?

  Sir Callum McCarthy: The difficulty that I see in giving two separate triggers, which is what would actually be involved, is that if I were responsible not in the FSA but in some other institution for deciding whether I was going to pull the trigger, and I knew that for example I would have to quite properly appear before this Committee some time to justify that decision or justify why I had not taken it earlier, it would inevitably push me into a degree of interrogation and quasi supervision of banks over an extended period. It is not just at the moment when you pull the trigger, it is an extended period of duplication, and I see very significant disadvantages in terms of clarity of responsibility, I see disadvantages for the banks involved who would be subject to that, and I do not think it is the sensible way of doing it.

  Q37  Mark Todd: Reading the internal audit report on the supervision of Northern Rock, Michael listed some of the failings that were identified and he was not as harsh as one might have expected. I think poor recordkeeping was conceded; a very high turnover of staff without proper monitoring of what happened when that was happening; very few visits and little personal engagement with the particular institution, very poor risk analysis and an acceptance that, in your words, an outlier in this industry was not treated as such; and very poor challenge mechanisms at senior management level of those who were directly involved in the supervision of the bank. If I read that in another institution I would regard that as a description of systemic failure and not a criticism of a particular group of individuals carrying out a function. Would you accept that view?

  Sir Callum McCarthy: I regard what has happened as having two deeply worrying aspects. One is there was a misjudgment of the risk involved in the Northern Rock business model and the second thing, which is of a different dimension, is that there was a failure by the management within the FSA to actually control a group of people who were not doing their job properly.

  Q38  Mark Todd: Most of whom you have retained in employment.

  Sir Callum McCarthy: No, I actually think most of whom, for one reason or another, are no longer with the FSA. What does concern me however, and what concerns the Board and what we have spent a lot of time looking at, was to try and establish whether this deeply worrying set of events that you have described was characteristic of the way in which the FSA supervises institutions overall or whether it was an outlier, and it is clear from the work done by internal audit and it is clear from the work that has been done elsewhere—and Hector can comment on this—that the Northern Rock experience was an outlier, a deeply worrying outlier, but it was not characteristic of the whole.

  Mr Sants: I would just make two points. Could I pick up on this "most of whom" of "the management" and could we just take that off the table. I have done the calculation in my head, and there are five managers in the chain involved here, and four of them are no longer with the FSA, and in my book one out of five is not "most", so I would be grateful if we do not use that terminology going forward.

  Q39  Mark Todd: I am glad you have quantified it.

  Mr Sants: On to the second point, we could dance around a pin a bit as to what we think "systemic" means, but I think we should be absolutely clear, and I think I have been absolutely clear about that, that the way the Northern Rock was supervised was unacceptable and to ensure that that does not happen in the future requires us not just to make changes with regard to the people who were specifically and directly involved in that set of events but also to make a number of changes across the whole organisation, both with regard to culture and system. I do believe we do need to make some general changes to ensure we can deliver going forward. I am confident we can but I am absolutely open about the fact that some general changes are required.