MS ANGELA KNIGHT CBE, MR PAUL CHISNALL AND MR ALEX MERRIMAN

13 MAY 2008

  Q160  Chairman: If you do, briefly.

  Ms Knight: I will also send you a letter on the subject.[2]

  Q161 Chairman: In simple language.

  Ms Knight: I agree. I can only understand it in simple language too! LIBOR is the rate at which a contributing bank would be prepared to borrow in the market. There are a variety of rates that are contributed by the different banks in advance of the fix. These rates are then looked at and an average is posted as the LIBOR fix. That does not mean that everybody can borrow at that rate. What it does mean is that that is the bench mark and a bench mark that is used worldwide. The questions that have been raised relate to volatility of dollar LIBOR only—not of LIBOR sterling and not of LIBOR euro but dollar LIBOR only—and that is one of volatility. Because of that, we have brought forward the annual review, we have contacted all the banks that are contributors to it and we speak to the Fed on a daily basis. Frankly, we have got a very sticky market out there; it is hardly surprising that you have rates that move in a different fashion than happened in the previous pretty benign conditions.

  Q162  Chairman: I think we will go further on this but I think we will correspond on that matter.

  Ms Knight: Yes, if that is all right, and I can let you have the graphs and the details, with pleasure, and also the outcome of the review, which will be available shortly.

  Q163  Mr Brady: Can I turn to the Special Liquidity Scheme, Angela. You have welcomed the scheme, but what results do you expect to come out of it, both for consumers and for participants in the financial markets?

  Ms Knight: What the Special Liquidity Scheme has done is it has provided some additional liquidity. To a certain extent you can argue that what it is helping to do is provide the securitisation opportunity because securitisation markets are closed and, extraordinarily, they are closed for first-class assets, and so we have got a particularly peculiar scenario out there. Banks, as you know, not only take a "hair cut" as far as access to the Special Liquidity Scheme is concerned, but they also pay for it as well. That additional liquidity should help in a number of areas, both in terms of helping on the longer dated LIBOR rates and also helping the banks own liquidity, and so on, to the sorts of lending than they can make.

  Q164  Mr Brady: Are we seeing any of that changed feeling coming through yet?

  Ms Knight: I think we are at the start rather than even the middle of that. I think certainly we are starting to see some sort of effect but, frankly, it is a little bit too early to plot, but we ought to be able to see it coming through to a greater extent over the next few weeks.

  Q165  Mr Brady: So within the next few weeks we should start to see a difference from the consumer perspective as well?

  Ms Knight: One of the things that the consumer is having difficulty with is the number of lenders who have, in effect, either pulled out of the market for new lending or are severely restricting it. You will have read, as well as I have, the reports of what is happening as far as the building society sector is concerned about the lending restrictions, and of course we all know that the Northern Rock clearly is unwinding its mortgage book. That means that a lot of the lending, particularly mortgage lending, that is taking place out there relates to re-mortgaging not just of the banks' own existing customers but re-mortgaging those customers who are coming off deals with other institutions which for various reasons are not finding the market making it possible for them to lend.

  Q166  Mr Brady: How do you respond to the suggestion that, given that it is such a large sum of public money involved here, it would have been reasonable for the Government or the Bank of England to put some restrictions, some expectations on banks participating in the scheme?

  Ms Knight: I understand your question. Perhaps I can answer it both broadly and then narrowly, if I may. Firstly, broadly, you do have to accept, and I am sure you do, that our central bank is acting in a similar way to other central banks around the world. We are not in a unique position here in the UK. Indeed, of course the European Central Bank has been much broader in its lending for some significant time as has the Fed. So we do not have a situation that is just the UK doing something, if you like, particularly differently to other centres, and one of the keys in all this is that major central banks act together. Secondly, as far as the responsibilities are concerned on the banks themselves and others who access the Special Liquidity Scheme, clearly they have to abide by the normal right and proper responsible criteria for the purposes of lending, and they also have to look at the broader portfolio they have and their other considerations, such as their capital requirements. So it is not a direct hypothecation, although, as I said earlier, it should actually help and assist the customers on a broad and general basis.

  Q167  Mr Brady: What more needs to be done either by the banks or the Government to get the mortgage markets working properly?

  Ms Knight: I think one of the keys here is, I am afraid, this whole area of securitisation. Is there something that can be done to open up the securitisation market for first-class assets? Unfortunately, it is closed around the world at the moment. This is one more, not of supply, but those who are on the buy side and perhaps reflects a number of things, not least what they already have and are holding in terms of securitisations. If there was a magic bullet, we would have let everybody know. There is not a magic bullet in this area. Some of the things that we are doing in the UK, though, I do think broadly will help. For example, the way in which the banks are declaring exactly what their position is, they are repairing their capital base where that is necessary, and they are making open declarations to the market. That is clearly a confidence builder and something that is important. We heard that all the other centres actually followed suit, but we could argue that only some centres are being as open and transparent in this way, and I do think it is a combination of transparency, it is simplicity, it is being also certain of what else is happening elsewhere in the world as far as the credit crunch is concerned that is of merit and value in freeing up our securitisation market and also, therefore, in assisting on the mortgage front. The wholesale money market, the other part of it, we wait to see what the money market funds do, because they are the absent party from that particular feast that is particularly noticeable.

  Q168  Mr Brady: Is there more that the Government could or should do?

  Ms Knight: I think it is quite difficult to say that there is more the Government could do. If we just had a UK securitisation market which was a problem, then I would say, yes, there was something potentially there that could be done. However we are looking at something that is the same in other countries, and that does not make it easy.

  Q169  Mr Brady: Looking at the wider credit crisis, to what extent do you agree with the Bank of England in its recent Financial Stability Report when it came to the conclusion that the overall extent of the crisis might be being exaggerated by the market?

  Ms Knight: We see why they say that, and I hope, in fact, that they are correct. It is in the areas of valuation and how you have to value your assets—as you know, the trading book assets are valued on a mark to market basis—when you do not have a market. There are models which banks can use. There are also times when you have a single price out there which is not a market but may be reflective of the price of your instrument. In the US they have had a noticeable spiralling down, which is caused, I think in part anyway, by a combination of their application of the mark to market rules and the way their audit profession is not necessarily allowing banks to make judgment. Inevitably that flows over a certain extent to the UK, even though here we have adopted international accounting standards and our models are robust. The Governor is right to make the points that he does; that there is a difference between an actual de facto loss and a valuation of something where currently the valuation may not be as good as it was but may well come back. These two do get muddled up and we, like him, believe that getting the proper separation out is the right way to go. It is, dare I say it, the involvement of the accounting and the audit professions, and, indeed, not just here in the UK, which will bring that about.

  Q170  Mr Brady: Are the institutions now being sufficiently transparent to allow proper evaluation of where we stand?

  Ms Knight: Yes, I think so. What you have seen, and continue to see in the UK, is pretty good transparency. We had, and you have made, criticisms of our market and criticisms of our industry, but, equally so, banks are good at being transparent and the market does bring about some of those declarations and some of those standards which one does not necessarily see elsewhere. In the UK we are all playing to the side of openness, transparency and, ultimately, confidence will return.

  Q171  John Thurso: I want to ask you some questions about the Special Resolution Regime, but before I do that can I ask you a wider question? Does the BBA membership regard itself as victims or perpetrators in the current financial crisis?

  Ms Knight: I think the true answer is probably participators actually. We are part of something which is happening around the world. Our members, as you know—many of them—have been involved and are involved with subprime, and you can argue that questions should have been asked, or were not asked as intently as they should have been. Equally, our members are very broad-based banks with a broad-based business model that not only serves them well but, importantly, serves their customer base well and the economy well. So I will still stick with being participators.

  Q172  John Thurso: I would like to challenge that. You said earlier that your members are good for the UK economy; that their products were wonderful. If you look at the many financial institutions and the impact they have had over a 20-year period, you could make a case to say they have been responsible for some quite phenomenal wealth destruction. If you are out there in the high street at the moment trying to run a business, you do not see your clearing bank as being terribly friendly as your rates go shooting up and you as a businessman are actually having to pay for the incompetence of the board rooms of the big banks. So, why are you so special and why will not anybody in the industry take responsibility for what they have done?

  Ms Knight: Let us try a few of those points. First of all, does the banking industry take risks? Does the financial services industry take risks? The answer is, yes. Does the engineering industry take risks? Does the pharmaceutical industry take risks? The answer is, yes. Do politicians take risks? Yes. The reality is that business is about risks and sometimes your judgment is right and sometimes it is not right, sometimes it is wrong, and that is true whatever business you do.

  Q173  John Thurso: What you try to do, if you are sitting on an audit committee or whatever, is assess risk?

  Ms Knight: Yes.

  Q174  John Thurso: And then price it. It seems to me that the banking industry has totally failed to actually assess risk.

  Ms Knight: I do not think that you can say the banking industry has totally failed. I think that is an exaggeration, if I may say so. What you can say is some banks in some areas did not get that risk right, and that is different. If you want to say to me that risk committees need to look at things more intently, better than they have done in the past, I think we would all agree the answer to that is, yes.

  Q175  John Thurso: What concerns me is that a sound banking system is absolutely fundamental to a good local economy?

  Ms Knight: Yes.

  Q176  John Thurso: And for many years we were never going to go back to Captain Mannering touching you on the shoulder and saying, "Look, old boy, it is time to slow down a little bit", but for many years one dealt with somebody, whether in the City or in the High Street, that had a clear understanding of your business and you had a clear understanding of their business. What you now have is legions of bright young things who have never run diddly-squat creating products that are now termed worldwide as "highly toxic", which board rooms had absolutely no clue about and which risk committees, audit committees could not even conceive of and are so complicated that, even after hours on this committee, I barely begin to understand them. Surely that cannot be right. Surely that is the moment the industry has lost the argument not to be regulated more thoroughly?

  Ms Knight: First of all, as far as innovation is concerned, I am sure that you are not trying to say that the industry should not be innovative. All industries need to be innovative. If they are not, then they will, first of all, stagnate and then they will decline. So innovation is as much part of the financial service industry, as much a part of banking as anyone else. Do I accept that some of the innovation might be right but may not have been controlled as well as it should? Evidently the answer to that question is, yes, and if you read the recent speeches of a number of US Treasury ministers, you will see that they four-square concentrate on that particular point, including some of the aspects about the rating of the subprime products, which was very unclear, as you well know. As far as industry closeness to its customer, be the customer the individual or be the customer a small business, medium-sized business, man or woman, in the towns and cities of this country, the industry certainly does not intend to be remote from them in any way. We track some of the statistics through the BBA, not all but some of the statistics through the BBA. For example, the ones which show how people choose to interact with their bank. One of the very noticeable things is that we are in transition at the moment. There are three ways in which people want to significantly interact with their bank: the Internet is the biggest, telephone is the next biggest, branches of course are still there. When you are in that transition period you are trying to satisfy three audiences, if you like, and it is not the easiest thing. The banks are like every other business insofar as they have customers, their customers can go elsewhere. Indeed, in banking it is much easier to change from one supplier to another than it is in many other walks of life. I accept that banking is important for the economy generally. That is one of the reasons why banking is regulated in addition to the other sorts of rules and requirements that hang around industry and commerce generally. Do we think that there needs to be reform of regulation? You will have had our response to the consultation document and, indeed, the responses to the wider issues which we touched on earlier, so the answer is, yes, there are some lacunas there. What we have to be careful about is not throwing out the good, not bringing in regulatory requirements which are either unessential or do not actually fit the right place; they do not meet the spot. As I said at the start—something that is unpopular to the committee—I think we also have to look at the international context, both in terms of the reputation of the industry, but also because the industry operates in multiple jurisdictions and some of the changes need to be done in co-ordination with the more global authorities.

  Q177  John Thurso: Let me ask you about the Special Resolution Regime. In your submission you note that it should be the Chancellor who decides whether the special regime is triggered. I think that is right, is it not? Why do you want a politician to take a technical decision? Are you hopeful that the constituents' interests will come through?

  Ms Knight: Not at all. We have a tripartite arrangement right now in which the Treasury is involved, the FSA is involved and the Bank of England is involved; so you have already got that link; you have already got three legs there. It seems to us that where the major emphasis needs to lie with this whole process is in better quality regulation, and that is the regulation itself as well as the regulators. We believe that the entire emphasis ought to be on that particular area. Nobody but nobody wants to have a scenario in which we have a repeat of the Northern Rock, and that, therefore, equates very strongly with better calibre regulation and better calibre regulators. Should an institution start to get into difficulties, then we favour what we call the "heightened regulation approach" where much more interest is paid on that particular organisation. Clearly it has to be done carefully, because one does not want to end up with the result that you are trying to avoid. Should we get to the point at which that institution cannot be rowed back out by regulation into safe waters, then the question arises as to what happens next. We believe at that point, yes, you have got a tripartite there, the FSA has to give its advice to the Treasury, to the Chancellor, as does Bank of England, but somebody has to take the decision. We believe the Chancellor then, as Chairman of the tripartite, takes the decision and the Bank of England employs the necessary tools to bring about the Special Resolution Regime from a practical operational perspective.

  Q178  John Thurso: Why not the Governor of the Bank?

  Ms Knight: We think that there needs to be a clear distinction between the roles and responsibilities of the regulators and of the Bank of England. I think we all can argue that that lack of clarity did not help in the Northern Rock situation. Regulation is for regulators, and that is why we say that that is the part which falls to the FSA, but we do think that the Bank of England has an opinion which needs to be heard at the point at which the SRR is decided. But, can I also say, we think there needs to be a good, high quality formal contact between the tripartite and that they should also operate what we refer to as a "no surprises regime", so there is information flowing between the bodies. The last thing one wants is somebody to have a surprise, and again it is arguable that surprises did occur with the Northern Rock. So, it is about clearly articulating the responsibilities of each but ensuring that there is a proper, formalised information flow taking place and a no surprises approach as well.

  Q179  John Thurso: I do not buy that. I do not think that is a good argument at all. One of the most successful things that have happened since 1997 was giving the Bank of England independence. It has added hugely to the general trust and confidence. I think one of the major problems of Northern Rock was the fact that the Chancellor was involved and there was not a clear-cut decision route that was independent of that. It may well be that he misconfirmed it, but it seems to me it should be either the FSA or the Bank that pull that trigger?

  Ms Knight: That is a fair point. I give you the view as we have discussed it within our community. We feel that it would be enormously surprising if the Chancellor did not feel that he had locus on this decision. We note in the consultation document the proposal for a COBRA arrangement, which we do not particularly favour. We certainly favour the Bank of England's strong role, both in financial stability and also in taking control, should a Special Resolution Regime be implemented. We also believe that the Bank of England clearly has an opinion which we want them to give before that SRR is decided, but for regulation we believe the regulation falls to the regulators and dual regulation is not something that would necessarily be beneficial either for an entity or for the wider community.