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

13 MAY 2008

  Q180  John Thurso: We have suggested that, ultimately, it is the Bank of England in that moment that should take charge. Do you disagree or agree with that?

  Ms Knight: Take charge at what point?

  Q181  John Thurso: Having charge for financial stability but, basically, when an institution is failing or has come to a point at which its regulation has failed, that is the moment the Bank of England should step in?

  Ms Knight: We agree with that.

  Q182  John Thurso: Can I move to depositor protection. You have taken a very strong line against the idea that the banks should build up funds into a deposit protection scheme. Why is that?

  Ms Knight: We think that the most important thing here is all about making sure that there are funds available, should they be required at the time, and that does not necessarily require, as you know, a build up of funds. We feel to start building up funds now is going to be disadvantageous to customers. Because of the nature of the industry here in the UK, you will either have a fund that is punitive or tokenistic, and we do note, of course, that it has taken about 75 years for the FDIC to get there with its fund and it only looks for small banks, as you know. So we reckon that we need to look at some of the practicalities of how, should failure occur, individuals get their deposits back and get them back speedily. That is the perspective that we have come from.

  Q183  John Thurso: Let me give you a scenario. The scenario is Bear Stearns came first, Northern Rock came second—in other words, instead of Northern Rock being the sort of eminence grise in this little financial crisis, it actually was a small player in one country, which is what it has actually turned out to be—and at that moment the Governor says, "Well, it is not actually that important, it is not systemic, so we will just let it go", so Northern Rock goes under rather than being saved. Four billion, I believe, is the amount that is held in the protection fund at the moment—clearly not enough—and there is clearly then some knock-on risk, and you might see others. At that point in the cycle, right at the debts, there is going to be no way the banking system can produce sufficient funds. Therefore, it comes straight back to a government bail-out. In the good times there is not a problem; the problems come in the bad times. Is it not the case that, by arguing the banks should not take steps to put some reasonable funds together, in fact what the banks are saying is, "We actually want to be bailed out the by the state when the nasty things happen"?

  Ms Knight: We are not saying that actually. If Bear Stearns had come first and Northern Rock had come second, then I sincerely hope there would have been early intervention and we would not have the problems that we have got here in the UK right now. However, if I take it on further and take your scenario of an entity that actually is not rowed into good waters by better regulation and where the Special Resolution Regime also does not resolve the issue via either a bridge bank or a directed sale, or whatever we would like to call it, so you have actually got something that you want to liquidate. At that point, which I think you have got to accept is a very long way down the food chain, how we would anticipate that happening, is that, there would take place as follows. First of all, using the systems of the failed institution. We do not think that it makes sense on any grounds to have a couple of million cheques being written by the Financial Services Compensation Scheme. However, we think that the FSCS should have the ability to borrow and for the banks to pay back whatever the difference is between the amounts that are paid out and the amount that the liquidated institution pays back to the compensation scheme. We note that in the US, of course, in the times that the pre-fund is used by the FDIC, they immediately levy the industry to top it back up. So we think that there is a route, which we are exploring in much greater detail with the Treasury, with the FSA and, indeed, if I may say, with the systems houses as well, because clearly there needs to be some practical resolution. I come back to my earlier point: we need to concentrate upstream of that failure. This is the thing that we need to prevent, and I hope that your committee, as well as the tripartite, will come up with the solutions that ensure that we have a sensible series of preventative measures here in the UK.

  Q184  John Thurso: I concur with you, we should concentrate on avoiding it and preventing it happening, but it will happen. It may take some time and it may be a long way in the future, but it will happen. The critical point that we have learned is that to avoid a run we need to have strong depositor comfort very quickly, and therefore we need a depositor scheme that depositors really have total confidence in. In order to do that, surely it is correct that, rather than the state funding the banking industry when it gets into trouble, given their profits when they are not in trouble, the banks actually ought to put something aside. It may be a mixture, it may be there is something aside and something comes later, but simply to go on a wing and a prayer, "We will just work it so it does not happen", I think is untenable?

  Ms Knight: I think the best way to avoid a run is to take early action. The next way to avoid a run is to explain what you are doing when you do something rather than let it leak out into the public domain, frankly. If we get to the point where a deposit protection scheme has to pay out, then we have, we believe, articulated the way in which that can take place that is appropriate, that is timely and, as you say, is paid for by the banks. We do not think that having some sort of pre-fund is a necessary requirement to bring about the correct outcome. Nor do we think that it is going to be particularly advantageous to the customer at this point in time.

  Q185  Chairman: Angela, four billion at the most is available. If a big bank goes, it is going to have a hell of a lot of money; so at the end of the day it is the taxpayer that is tiding you over here, is it not? However much it works, at the end of the day the banks do not have the money, they do not want to put the money up front, the taxpayers will only do it with the Government and then you will see if you can pay them back at some time and then your members will probably quip about the interest rate that has been charged by the Government.

  Ms Knight: Chairman, I know of no country where there is not a back guarantee of their deposit protection scheme. You will know that there is of the FDIC. Let us get that clear.

  Q186  Chairman: Let me just tell you. I went to see the American Bankers Association.

  Ms Knight: I know you did.

  Q187  Chairman: Thinking that they would say, no, but they said a pre-funded scheme is essential for the banks to show their integrity. What I am trying to get out from you here, Angela, is are the banks going to show something in terms of the mess that we are in now that at some future stage the public will be able to see some slither of their integrity and not wait for the Government and the taxpayer to bail them out again? What are the banks going to do to say, "Yes, we are going to have some responsibility here"?

  Ms Knight: If you want me to say, Chairman, that the way to do that is to put in a pre-funded deposit protection scheme, I am afraid I do not agree with you. I am sorry, I do not agree with you. I cannot agree to something that does not look like it is going to work.

  Q188  Chairman: I am looking for you to show some commitment that the banks are going to put something in; that the banks are going to be in a position to say, right, the financial services industry in this country is good for the country, but it is good for the industry itself. At the end of the day, if somebody goes down, we should be like any other company where the shareholder takes the hit. In order to develop confidence in the market, we are going to say that, if a situation comes round where a bank feels that, we are going to be upfront somewhere and assist the Government in that; we are not going to wait for the Government to do it 100%. That is where I am looking for you here to build something out.

  Ms Knight: That is a point taken, and I say to you again, Chairman, we are in discussion right at the moment with both the Treasury and the FSA on some of these issues because, like you, we want to ensure that there is confidence to the customer and confidence in the banking system. Your points are well made. We want to get to the right conclusion.

  Chairman: If we drag you gently, you will not squeal, will you!

  Q189  Ms Keeble: You said that regulation is for the regulators?

  Ms Knight: Yes.

  Q190  Ms Keeble: But actually the regulated have got an obligation in all this as well. What do you think should be done by the banks to ensure that when warnings are given they are actually heeded and acted on?

  Ms Knight: I did say regulation is for the regulators. I was talking in the context, of course, of who took what responsibility when moving to and then enacting an SRR. Of course, banks, as indeed every other institution that operates in the financial services industry, have responsibilities to implement the requirements, the rules and the spirit of what is intended. I am not sure of the point behind your question; I am sorry.

  Q191  Ms Keeble: You have supported our suggestion that there should be a mechanism to ensure that warnings by the authorities are heeded by the banks. How would that work?

  Ms Knight: We were talking, I think, in that context about early warning systems and we, again, think that that is probably far more international than it is local. I think that there are some issues which, for example, the IMF could, indeed, look at and some trigger mechanisms they could, indeed, look at to make some of the international issues and warnings around them known rather better and clearer. I understand that that is exactly what they are considering doing.

  Q192  Ms Keeble: You have also said that you would like the Special Liquidity Scheme to become part of a more flexible approach to the banks' future money market operations?

  Ms Knight: Yes.

  Q193  Ms Keeble: Again, that comes back to: what are the banks then going to do? It picks up on the other points, but why should the banks be given that type of support unless they are prepared to heed the warnings and apply more due diligence to some of their investments?

  Ms Knight: Firstly, I do not know of warnings that banks have not heeded, but let us get to your particular point. The question about the money market framework and making it more flexible is this. We have a money market here in the UK, there is one in Eurozone, there is one in the US, there is one in Switzerland—there is one in every other major centre. We have banks operating here in the UK that also operate in those other centres. One of the things that we think is important is that the money market regimes harmonise better than they do at the moment. A point that was most noticeable as we passed through the summer of 2007, when our money market dried up, was that those banks who operated in the other centres where there was a greater flexibility, particularly in terms of collateral and rate, could access money, liquidity, out of other centres, whereas those which were solely UK based could not. So it seems to us that we need to have a look at our money market framework, and, indeed, the Bank of England is doing that, both in the short-term and also for the longer-term, and bring together, where it is possible to bring together, similar frameworks in other countries. Again, that is something that all the central bankers are looking at. As far as how do central banks work, central banks and how they work was decided when central banks were set up. I do not think you need me to go back to that point, to the beginning. Flexibility is about handling different scenarios and it is about the fact that there are multiple markets out there that need to have, in our view, a greater degree of harmony, where possible, on collateral and on the systems that they operate.

  Q194  Ms Keeble: Can we go back to the incentives issue again? You rejected that point on the basis of frightening people away, et cetera. It seemed to me that what was being said was perfectly reasonable. It was not that banks could not do it, it was that it had to be assessed and it had to be included as a risk factor, which is just about pricing it properly. What is the problem with that?

  Ms Knight: In assessing?

  Q195  Ms Keeble: If you are assessing the risk, then one of the risks is the pay structure for some of the senior staff?

  Ms Knight: I do not have a problem with that. I keep saying, I do not have a problem with that.

  Q196  Ms Keeble: You do not have a problem.

  Ms Knight: I do not have a problem with looking at pay structures. Firstly, looking at pay needs to be done more internationally. Do not forget that 60-70% of the institutions operating in the UK are not UK-based, they are from overseas; so if you are going to look at pay structures for international entities, then you need to look at them internationally. That is the first thing. Secondly, what I did say is that I am mindful of the reputation of our centre, and I do not see any problem with being mindful of it. I do not know if you have looked at the pay for the chief executives of the FTSE 100s, but you will find that the banks are broadly in line with the pay of the FTSE 100 chief executives.

  Q197  Ms Keeble: We are talking about completely different issues, if you are comparing those issues. What we have heard quite a lot of this morning is what everybody else needs to do, and I think what we are saying is what are banks going to do, in particular, given the consequence is that all of our constituents are paying for what has happened over the Northern Rock debacle where there were clearly failures in what happened around the governance of Northern Rock?

  Ms Knight: I agree.

  Q198  Ms Keeble: That has been gone through. There were warning signs that were not heeded. It is always easy to be wise with the benefit of hindsight, but that happened. We have seen the presentation this morning, and you have said a lot about the regulators have to change, they have to look at international markets, they have to do this and that, and I think what we want to know is, that is fine, but what are the banks going to do?

  Ms Knight: Northern Rock was, as you rightly say, a real problem. You have looked at that very closely here as a committee. We would support the conclusions that you have come out with. As far as your earlier presentation, I did not see your earlier presentation. What are the banks doing about ensuring that their risks are controlled, that they rebuild their capital if that is necessary, that they continue to lend, because that, of course, is part of their operation. You see that out there, you see that in newspapers, you see that on a daily basis. As far as pay is concerned, which is where you started, board pay in the UK is subject to shareholder vote. We have actually a pretty open process here, and whilst some will quite rightly say, "Ah, but that is only the board", you do also in that shareholder vote and in the annual reports to shareholders in the AGMs set out the structure of pay that operates within the bank on a general basis as well as with individuals. Of course pay is a question, of course pay is one of the things that is being discussed and of course pay is something that is being looked at both here and elsewhere. I think you do need to be careful, though, that you do not just say, "Oh well, the problem is just because a few people got paid too much." We are in a world credit crunch, a problem that started in the US with the unregulated mortgage selling. We are part of a system that is causing difficulty everywhere. In the UK we are being transparent about the issues, transparent about our problems, transparent about our inquiries, and I do hope that that is recognised.

  Q199  Ms Keeble: You if look at the FSA's discussion paper on liquidity regulation, they have put a number of proposals. What do you think of those and how do you see them as moving forward, particularly as some of them are very vague?

  Ms Knight: We will have to send you our response to the liquidity discussion paper, because it was actually long and it is detailed. Much of the FSA proposals we support. I cannot actually, off the top of my head, think of anything particular that we had a question mark about other than the need to use Basel to look at liquidity issues. So, I apologise, I cannot remember the detail, but I will let you, as I say, have a copy of our response in full, and to the rest of the committee, Chairman, of course.