UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 548-i

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

Scottish Affairs Committee

Dunfermline Building Society

Wednesday 20 May 2009

MR JON PAIN, MR ANDREW BAILEY AND MR CLIVE MAXWELL

Evidence heard in Public Questions 1 - 123

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Scottish Affairs Committee

on Wednesday 20 May 2009

Members present

Mr Mohammad Sarwar, in the Chair

Mr Alastair Carmichael

Mr Ian Davidson

Mr Jim Devine

Mr Jim McGovern

Lindsay Roy

Pete Wishart

________________

Witnesses: Mr Jon Pain, Managing Director of Retail Markets, Financial Services Authority, Mr Andrew Bailey, Executive Director Banking and Chief Cashier, Bank of England, and Mr Clive Maxwell, Director, Financial Stability, HM Treasury, gave evidence.

Q1 Chairman: Good afternoon, I would like to welcome our witnesses to the session. Perhaps you could introduce yourselves for the record.

Mr Bailey: Andrew Bailey from the Bank of England; I am the Executive Director responsible for banking at the Bank of England and I am also responsible for any Special Resolution activities that the Bank of England has to do which therefore includes Dunfermline Building Society.

Mr Maxwell: I am Clive Maxwell, I am the Director at the Treasury responsible for financial stability.

Mr Pain: I am Jon Pain, Managing Director of Retail Markets, Financial Services Authority.

Q2 Chairman: I know that one of our witnesses, Mr Pain from the FSA, has to leave at 3.30 so we will try to finish our business before 3.30 but at the beginning we will probably focus questions relating to Mr Pain. Before we start on detailed questions would you like to make any opening remarks?

Mr Bailey: No.

Mr Maxwell: No.

Q3 Could you tell us why did Dunfermline fail and who was responsible for the DBS failure?

Mr Pain: I wonder if I could lead with a few comments in that regard. I suppose there were a number of factors that ultimately led to the firm's failure. Its previous management had made some poor management decisions that substantially weakened the outlook for the firm in a more difficult market condition environment, but in particular its diversification into commercial property lending, its purchase of non-core lending/mortgage portfolios from third parties and its inability to adequately control its cost base, particularly its IT investment. Finally, and probably importantly as well, in terms of the overall market confidence there was a heightened awareness of its difficulties. It was widely known that it was going to be substantially loss-making in 2008 and this reflected in its poor credit rating which would have impacted on its ability to raise wholesale funding. Against this and in the absence of any new capital that was required the firm's own management and board concluded that it did not have a viable future.

Q4 Chairman: It has been reported that DBS lost £9 million on its IT system and perhaps you could tell us to what extent was their own IT system failure responsible for their overall failure?

Mr Pain: It certainly played a part, Chairman; I would not take out of context the degree of the part because as you rightly say the firm had to write off nearly £10 million. It was a substantial investment, in the order of £30 million, which is large for a firm of this size, particularly against its cost base - it actually had a cost base in terms of its cost income ratio where we measured its cost efficiency as being one of the highest in the sector, so it definitely contributed, it did not help in respect of having that drain on its resources.

Q5 Chairman: An argument has been given that in order to stay afloat, Dunfermline had to expand to riskier lending business to counter the banks' "cut-throat" mortgage practices. Those practices of the banks brought the system down, but the banks were rescued, leaving Dunfermline with the risky debts. How do you respond to the argument that it is unfair that the banks, which orchestrated this crisis, were rescued by the Government with the injection of billions of pounds and on the other hand they sacrificed this small business?

Mr Pain: Chairman, that might be a question more for Clive Maxwell to answer.

Mr Maxwell: Maybe I can answer that. The first part of your question is about the decisions that the business itself made about the ways in which it wanted to make profits, and they were clearly decisions for that business itself. Different organisations, different building societies have chosen to handle things in different ways. When the society was in difficulty the Government looked at it, like it looked at other situations, with three objectives in mind: firstly the need to protect depositors, secondly to ensure stability and confidence in the financial system and thirdly to safeguard the interests of taxpayers. In taking the decision that the Government was involved in, which was whether or not to provide any support to the society, it took all three of those issues into account and then looked at the conditions it had set for its recapitalisation scheme, which really requires the organisations receiving the capital to be adequately capitalised with funding or have realistic plans to be so and to have sustainable business models. It took the decision that those conditions were not met in the case of this building society.

Q6 Chairman: Nationwide was given almost £1 billion by the Treasury and the critics say that a fraction of that money was not given to DBS to leave it as an independent organisation which has been established over the last two centuries.

Mr Pain: The funding provided to Nationwide has been part of that transaction, transferring a set of assets and liabilities to Nationwide. Andrew can perhaps explain the nature of that transaction more fully but it should not be regarded as an absolute cost to the taxpayer but as being in the form of funding. The costs of this resolution will firstly be borne by whatever remaining reserves there were from Dunfermline as part of the administration process and, secondly, by the Financial Services Compensation Scheme.

Mr Bailey: It is very important to draw a distinction between what you might call the capital shortfall that was within Dunfermline and the number that you quoted which is the amount of funding. The amount of funding has been put there as a means of ensuring that the depositors in Dunfermline were taken very quickly into a safe home, and from the point of view of the Bank of England's responsibility as the resolution authority, that is the thing that is most important, that the depositors in Dunfermline at the end of this process, which has to be a very fast process given the confidence issue around deposits and banking, were taken to a safe home very quickly. There is a clear distinction, therefore, between the funding which will be recovered, will come back in time, and the capital shortfall. The capital shortfall was of course nothing like the figure that you have for funding.

Q7 Pete Wishart: It is reported that all the Dunfermline Building Society required was a £60-£100 million loan in order to continue to thrive; was that properly considered and why was that totally rejected by the Treasury?

Mr Maxwell: The options were very fully considered. I should say that it was not a £60 million loan that was considered, it was a form of capital injection that would have been required to meet the shortfall in the balance sheet of the society. All banks and building societies are required by prudential regulations to hold capital above and beyond the assets that they hold; they must have total assets which exceed their liabilities by a certain amount in order to protect their depositors, to protect other people doing business with them, and in the case of Dunfermline there was insufficient capital and that would have needed to be replenished.

Q8 Pete Wishart: What would have been the figure required in order to allow Dunfermline to continue trading?

Mr Maxwell: The figure that has been quoted in a number of public documents has looked at how much would be needed immediately to allow it to do business and that is £60 million, but I should stress that that was in order for it to get through the short term. There are also questions here about the longer term ability of the business to carry on.

Mr Bailey: If I could perhaps just add one point there, Clive is right that in a sense you might say what is the immediate need, but in a banking problem where the issue is confidence - again this is the dominant feature of why are banks different from other companies, it is the issue of confidence, the confidence of depositors - I do not think we were at all confident that a solution which did not address the problem for the foreseeable horizon - and the foreseeable horizon is longer than the £60 million issue in my view and therefore it is considerably bigger - would have created the sort of confidence that would have put Dunfermline back onto a stable path. There was a real risk around that, that if we did £60 million we would have immediately got extensive commentary and extensive coverage saying this has not done it, this is a temporary fix, a band aid type solution, and we would have very quickly been back to the drawing board again.

Q9 Lindsay Roy: Good afternoon, gentlemen. As an extension to that it is my understanding that not only was there a one-off loan from Her Majesty's Treasury rejected as an option but so also was a reported offer from the Scottish Executive. Why were these options not taken up or seen as desirable?

Mr Maxwell: The first thing, as Andrew said, is that it was the judgment that even with the injection of £60 million the Society would be very unlikely to have an independent long term future and that would have led to worries about its sustainability. As I stressed, what was needed was a capital injection, it was not a loan which would be repaid, it would be a simple transfer of assets in the form of capital that the society needed. The Treasury looked at the situation; it looked at the conditions set out for its recapitalisation scheme which had been announced towards the end of 2008. Those conditions are firstly that any firm seeking to access a capital injection from the Government should be either adequately capitalised and funded or have a realistic plan for accessing adequate capital and funding and to have a sustainable business model, and the assessment made was that Dunfermline was not adequately capitalised and it did not have a realistic plan for accessing that adequate capital. Taking all of these things into consideration the Chancellor concluded that it would not be in taxpayers' interests to contribute public funds to the Dunfermline.

Q10 Lindsay Roy: To what extent was there any exploration about a sustainable business model? What level of discussion was there with DBS representatives?

Mr Pain: I will answer that if I can, Mr Roy. There were extensive discussions with the firm over a number of months in respect of them trying to understand its options and its viability in terms of its business model. We had plans presented to us to try and understand what those were over the three and five year horizon, so there was extensive discussion in terms of those issues.

Q11 Lindsay Roy: In terms of the discussions did you or your colleagues point out where you felt there were deficiencies and ask for these to be addresses?

Mr Pain: Indeed, Mr Roy. It comes back to the point made earlier, of course, that the fundamental deficiency is one of capital, but notwithstanding that these are very difficult circumstances in terms of economic circumstances for firms like Dunfermline, so the whole viability of its ability to generate profits going forward and sustaining its current position, those were all factors that were taken into account as part of that discussion.

Q12 Mr Devine: Basically the three of you are saying that this building society was not saveable or its business model was not saveable.

Mr Bailey: As a whole.

Q13 Mr Devine: As a whole, and £60 million, £100 million, £500 million, a billion pounds, was not going to change that.

Mr Bailey: There is some value which would change that, yes.

Q14 Mr Devine: That is what I am asking, what would have been enough? £60 million was not enough, £100 million was not enough, the extra £25 million from the Scottish Government was not enough; what would have been? What sort of figure are we looking at that would have maybe turned this around? I am not asking about taxpayers' value, I am just asking in your experience what would have turned it around?

Mr Maxwell: I should mention one other element in that judgment about the sustainability, and that is if you are putting more capital into a firm such as this the provider of that capital expects to get a particular rate of return on it and the Society involved has to be able to make the payments. The typical capital instrument to put money into a building society would be a permanent interest-bearing share and the provider of the capital would expect to have an interest repaid on that. This society had made losses according to its last accounts of ---

Mr Pain: North of £24 million.

Mr Maxwell: The likelihood therefore of it having sufficient profits to be able to pay the sorts of interest required on those sorts of instruments did not seem realistic.

Mr Bailey: That is right. It had never made much more than £6 million profits a year, in a single year, so again picking up on the point that Clive has made, if there comes a certain size of capital that you put in and it cannot service that capital from its income stream - moreover if it uses all its income stream to service that capital it is not building its capital for the future - I am afraid that then tells you a pretty clear story about where this institution is. There is a number that would sort of fill the gap; the problem as Clive has pointed out is that it could not actually pay the rate to service that number.

Q15 Mr McGovern: Could I just ask about something you said earlier, Mr Bailey, in answer to a question from Mr Devine when you said that Dunfermline was not saveable as a whole; so I am clear in my mind do you mean parts of it were saveable and parts of it were not saveable but as a whole it was not saveable?

Mr Bailey: The point we were making, and it goes back to the point I just made, is that there was not a solution that we could see which kept the whole thing together as an independent entity, recapitalised, able to service that capital through the income that it earned. That is my point.

Q16 Mr McGovern: You will have to excuse me, I am not an economist or a banker or whatever but when you say it was not saveable as a whole, what exactly do you mean?

Mr Bailey: What I am saying then is that anybody who had acquired ---

Q17 Mr McGovern: Saveable in parts.

Mr Bailey: Parts, yes, because as we will no doubt come on to, as you can see, we were able to do that but it was not the whole of the institution, that is the point. There were parts of the institution - going back to the point that John made right at the beginning in terms of describing the problems that the institution had - where the problems were concentrated, so what we were able to do then was to separate those parts out from the good part frankly and deal with the good part, save and sell the good part.

Q18 Mr McGovern: But as a whole it was not saveable and you are happy to be quoted saying that.

Mr Bailey: Yes.

Q19 Pete Wishart: How does it compare with other banks that were saved, just to try and get a perspective between the problems that Dunfermline had and the Royal Bank of Scotland or Bank of Scotland, were they not saveable but saved, whereas Dunfermline was also not saveable but not saved.

Mr Bailey: We can all answer this question because we have all had a lot of experience, sadly, over the last two years now. I would compare it, frankly, with Bradford and Bingley which was a bank which we could not save and, again, we could not save it because there were parts of it which had losses in them which were sufficiently large that there was not a solution that was economic, that was affordable for the institution and would have kept it whole and independent.

Mr Maxwell: The objective of saving parts of the business, in particular the deposit book, was to allow the retail savers in that institution to carry on going about their normal business and transacting if it had been saved.

Q20 Mr Davidson: Can I pick up the question of how these huge losses actually came about? We have moved on a bit now and we are talking about should any of the passengers have been revived as it were but I am more interested in who drove the car into the wall. Can you just clarify a bit for me what a mutual was doing involving itself in commercial property lending? My idea of a mutual is that it is safe, it is secure, it is somewhere people put their money in order that collectively they can lend and borrow and so on and so forth. What were they doing diversifying into commercial property lending, which has always struck me as a little short of gambling? Surely somebody amongst yourselves must have had responsibility to say, "Look, this is just far, far too risky, you are being irresponsible, stop it."

Mr Pain: If I can attempt to answer your question, Mr Davidson, firstly there is an important point to be made in respect of how the activities are actually regulated and allowed in respect of individual building societies. The Building Societies Act sets out what those activities can be and actually sets a parameter that is laid down in the legislation in respect of the proportion of its activities that can actually, in effect, be non-core activities in terms of lending, so what Dunfermline was doing at that time was completely within those boundaries - the boundary is 25 per cent of its total assets can actually be in non-core activities.

Q21 Mr Davidson: How close to the limit were they?

Mr Pain: I have not got the figures in my head or to hand, Mr Davidson, but they were well within those limits.

Q22 Mr Davidson: Is well within that they were only doing five per cent or well within that they had gone over 21 per cent? I am just anxious that a mutual that I consider ought to have been something that was safe and secure got into basically gambling. Were they pushing the limit or were they just a little bit away from it? I am just trying to get a feel for these people that drove the car into the wall.

Mr Pain: My understanding would be that they would be well within those limits, they were not on the boundary fences as you describe it.

Q23 Mr Davidson: Nobody saw this as being potentially a difficulty amongst the regulators, it was just considered entirely appropriate, was it, that they were getting not right up to the limit but moving in that direction?

Mr Pain: That was the framework in terms of what they were permitted to do under the Building Societies Act and then in conjunction with that, in terms of building societies extending away from their core activities, we issued repeated warnings both to the industry collectively and to individual CEOs of the dangers of actually migrating away from pure mortgage lending and the risks that are inherent in terms of that. In the letter sent out from Adair Turner to the Chancellor you will see that there is a pattern of consistent reminders from the FSA about what those risks are to make sure the management were alive to those issues.

Q24 Mr Davidson: Can I just clarify, the Dunfermline Building Society would have had repeated warnings from yourselves about doing the things that they were doing.

Mr Pain: Absolutely. The collective industry were advised of that through various means; some of those were what I would call Dear CEO letters, they are written to all the CEOs of the sector, some of those are actually in direct speeches to the Building Societies' Association. That is one level of warnings of those inherent risks in terms of thinking about those risks before you proceed with that diversification. In addition to that and vas part of our supervisory process, throughout the last two or three years, we have increased the intensity of those issues, bringing those to the attention f the DBS management team and board, and by way of illustration you will see again set out in the letter that Adair Turner wrote to the Chancellor that actually we made, as part of our arrow process, which is our review of the risks inherent in any particular firm, we drew their attention to the controls of their commercial lending and that actually involved them in tightening those controls up. In 2007 they came to us to talk about acquiring another portfolio and after dialogue with us they actually then retreated from that deal and did not proceed with that deal.

Q25 Mr Davidson: They would have gone even further if you had not stopped them, is that fair?

Mr Pain: That would obviously be a question for that management.

Q26 Mr Davidson: They were considering investing, they approached you about it, you warned them against it and they backed off, the implication being that if they had had their own way they would have gone even further and taken even more irresponsible decisions.

Mr Pain: On the basis I suppose that they approached us wishing to do that deal, that would be the conclusion I would draw, Mr Davidson, yes.

Q27 Mr Davidson: It would be fair to say in all of this that the people who were running the Dunfermline cannot say that they did not know because they were warned often enough about the sort of behaviour that they were undertaking and the risks they were running, is that fair?

Mr Pain: It is fair to conclude that there were plenty of warnings in the forms that we have set out.

Q28 Mr Davidson: I touched at the beginning there on the commercial property lending; this question of warnings, did that apply only to the commercial property lending or does it also apply to the purchasing of the high risk self-certified mortgages from the American firms? Were the warnings covering both of those or did they need another set of warnings for the self-certified mortgages?

Mr Pain: The warnings covered the scope of what you are referring to, Mr Davidson. We talked about commercial lending, we talked about diversification into buy-to-let, we talked about the acquisition of non-performing specialist mortgage portfolios from third parties. All those issues were covered.

Q29 Mr Davidson: So they were repeatedly warned about both things that caused them the most difficulty eventually.

Mr Pain: In the context of how I have described how those warnings were communicated, yes.

Q30 Mr Davidson: The other thing that seems to have gone wrong is the IT system, and again the Government is not necessarily in the best position to lecture other people about IT systems. Presumably they were just left to get on with that; that is not something that anybody supervises, is it?

Mr Pain: Actually it is something we take a close interest in because it actually refers to the effective systems and controls of a firm, so again one of our arrow processes actually brought out the fact that that was a project that as an investment was poorly managed, they had issues with it and those were part of our intensive dialogue with the firm at that time, over many months, so it was not just a one-off occasion.

Q31 Mr Davidson: It was the IT project that you warned them was badly managed or the whole society.

Mr Pain: No, I was referring then to your particular question.

Mr Davidson: Fine, thank you.

Q32 Mr Carmichael: If I can just pick up on Mr Davidson's point because I am having difficulty just following your logic in its entirety. You are saying that the warning signals were not there because they were within their limits, they were not riding too many horses. You are sending them a series of what I think you are describing as effectively round robin letters, Dear CEO letters, yes?

Mr Pain: We are doing both. The earlier point was, if I can use your expression, that there were round robin generic letters - and those are fairly specific - written to individual CEOs across the sector as a whole. There were repeated issues raised to the BSA and then, in particular, with this particular firm as part of our ongoing supervision process in 2005 and 2007 we raised particular issues about the controls of its particular portfolio.

Q33 Mr Carmichael: That was 2005 and 2007. What were the terms of these specific issues?

Mr Pain: They were part of the supervisory risk review process and one of the issues that was raised in the arrow report and is highlighted in terms of the letter that is highlighted here was this question in November 2005 of the control issues in respect of the commercial portfolio.

Q34 Mr Carmichael: You have got a letter in 2005, you have got another one in 2007 and you have a train wreck in 2009.

Mr Pain: I obviously did not complete that whole story when I was answering Mr Davidson's question, but subsequent to that in 2008 there was a specialist KPMG report in terms of the overall position of the commercial book as well. There was a series of interventions and dialogue about the state of the commercial book and other related portfolios.

Q35 Mr Carmichael: How alarmed were you as a regulator in 2005 and 2007?

Mr Pain: Concerned enough obviously in 2005 that that then resulted in acquiring some external expertise to come in.

Q36 Mr Carmichael: Did it not concern you that you could have concerns but a business could still apparently be within its limits? You see where the logical inconsistencies come in here. Did that maybe not raise a few doubts in your mind that maybe the limits could have needed a wee look at again.

Mr Pain: In fairness the limits are, as I have already indicated, enshrined as part of the legislative framework, so it would be a matter for Parliament to decide whether those limits were appropriate.

Q37 Mr Carmichael: Were those representations that you were making to the Treasury at the time as a body?

Mr Pain: I am not aware in terms of that.

Q38 Mr Carmichael: Maybe Mr Maxwell can tell us; were you getting frantic phone calls from the FSA saying these companies are going to hell in a handcart but we cannot do anything about it because you have given us the wrong limits?

Mr Maxwell: I would have to check but I am not aware of any such correspondence.

Q39 Mr Carmichael: It is the sort of thing you would maybe remember.

Mr Maxwell: I would just make one point - and Jon could provide more on this - which is that when the FSA has to make judgments about the way in which firms are behaving there is the legislation but there is also the sense that the firm has to be operating in a particular way, it needs to have the ability and the skills and the experience of the individuals involved. There are a whole series of qualitative judgments that have to be made around these issues as well as hard and fast numbers on capital and the like.

Q40 Chairman: What you are telling us is that the FSA and the Bank of England were spot-on and it was just the failure of and incompetence of the management, the boards of directors of these financial institutions, that was responsible for the downfall of these banks and building societies? I find that hard to believe.

Mr Maxwell: The primary responsibility for running a bank or a building society lies with its board of directors and its management team.

Q41 Chairman: The responsibility for checks and balances lies with the Bank of England and the FSA.

Mr Bailey: Can I just qualify that? It is not the Bank of England's responsibility to regulate banks, that is of course with the FSA.

Q42 Chairman: If the FSA thinks that financial institutions are not taking their advice seriously then of course the FSA will report it to the Bank of England.

Mr Bailey: No, the remedial measures lie with the FSA. The Bank of England actually only comes into it - and I should say this is very recent because in fact the legislation that was used to resolve Dunfermline was only passed in February of this year, so it was actually only a month after it came in - at that very late point in the whole story. We are not in a sense part of the continuous story and we certainly do not have remedial powers of our own, those are with the FSA.

Q43 Mr Carmichael: Could I maybe just finish this? It seems to me that there may well be some substance in what you are saying about the conduct of the DBS as a whole but just within the confines of these four walls, in retrospect do you not think that there is more that you could have done as regulators to highlight what was coming down the tracks? Do you think you served the public interest well in the way that you dealt with Dunfermline Building Society?

Mr Pain: If I look across the spectrum of those years, Mr Carmichael, against the expectations of the mandate the FSA was working to at that time, the levels of warnings we gave to the industry collectively and then to this firm in specific terms, and then how we tried to deal with the resolution of the firm towards its end, then we did. I accept, however, that the expectations of the role of the FSA have changed over that period of time.

Mr Carmichael: Let me get this right: it is not the fault of the Bank of England because it is not your job; it is not the fault of the FSA because you were set up with an inappropriate mandate and it is not the fault of Treasury because you have set up an arms' length regulator, is that what you are telling us?

Chairman: Who is to blame?

Mr Davidson: I would have thought it was Dunfermline Building Society should have a certain share.

Q44 Mr Carmichael: If we have regulators there to regulate, why was the regulation not happening? If the Dunfermline Building Society has been so culpably reckless - and I am not challenging that assertion - why is it that nobody seems to pick it up in a meaningful and active way before the train wreck happens? Is that not what you are there for?

Mr Pain: Sure. As our Chairman set out in the letter that he wrote to the Chancellor he tried to describe, over that period of time, the expectations in terms of them and how we developed against those expectations a more intrusive and challenging aspect of regulation. It is clear to say that over almost a five-year time period the expectation of the role of the regulator has changed, but I do repeat what Clive has already said: ultimately the activities of the management have a significant bearing in terms of then what happens to a particular firm.

Q45 Lindsay Roy: Gentlemen, I am sure you appreciate that we receive briefings prior to this meeting and I just want to check the validity of something I have in writing here about the number of warnings that were issued from 2003 onwards. The briefing then says, "However, DBS was allowed to increased its commercial property book five-fold to £628 million between 2004 and 2008 and buy mortgage books worth £467 million from Lehman Brothers and GMAC." The FSA did intervene in October 2007 to prevent another £160 million book from Credit Suisse." Is that accurate, is that true?

Mr Pain: Mr Roy, in terms of the building of the commercial portfolio from 2004 of about £112 million through to £600 million odd in 2008 that is an accurate description but there are a couple of things that are important to bear in mind. One is that the actual drawdown of the most significant increase in terms of that growth between 2007 and 2008 was already commitments that were made to borrowers, so all they were doing was drawing down on already agreed facilities. There was then an appreciable slowing down of the activities and Dunfermline actually ceased any commercial activities in terms of lending in 2008.

Q46 Lindsay Roy: Who made the decision then not to invest taxpayers' money in DBS?

Mr Maxwell: Not to invest taxpayers' money?

Q47 Lindsay Roy: Who eventually made the decision?

Mr Maxwell: That decision was the Chancellor of the Exchequer's.

Q48 Pete Wishart: It was reported that Mr Falls, a former chairman of Dunfermline Building Society, went to the press and said that one of the reasons why the Government were not interested in helping Dunfermline Building Society was because of the involvement of the Scottish Government because they had been approached. Can you categorically deny that that is the case, that that had nothing whatsoever to do with the Government not getting involved in helping save Dunfermline Building Society?

Mr Maxwell: As I said, the decision was taken based on value-for-money assessments in the way in which I described.

Q49 Pete Wishart: Why did Mr Falls think that that may have been the case?

Mr Maxwell: I do not know.

Q50 Pete Wishart: There was nothing said, nothing hinted, nothing coming out of the Treasury at all to say because the Scottish Government are getting involved we have nothing whatsoever to do with this?

Mr Maxwell: I do not know.

Q51 Chairman: In terms of the tender for Dunfermline, how many organisations were involved in this tender and was there any possibility of a takeover by any other bank or building society?

Mr Bailey: The simplest thing I can do is say to you that we received four bids. I hope you will understand that I am not going to comment on individual institutions that bid for it because that is covered by commercial confidentiality, but there were four bids received and out of that we determined, as Clive has said, the best one that fitted the objectives that the Act and the regime give us, which are the three things that Clive mentioned earlier.

Chairman: Thank you. Can we move on now please?

Q52 Pete Wishart: Just to go back to the role of the FSA in all this, you vigorously contested the suggestion that you stood idly by while the building societies were going to the wall when it was published in the Financial Times but it seems to me that sending these letters around and maybe getting in touch with CEOs on a regular basis was all you did. What else have you done in order to alert the building societies to the difficulties they were getting themselves into?

Mr Pain: As I have already tried to explain, Mr Wishart, it varies for the individual firms in terms of their own individual circumstances so we do tailor our approach in terms of individual firms and our supervision of those individual firms to their unique position in terms of what activities they are undertaking and what risks they are taking on board. That is very much our tailored approach in terms of particularly the larger firms across the marketplace as a whole. Without repeating all that I have said I am confident that we did give very clear signals in respect of the issues and risks of diversifying away from those mainstream activities.

Q53 Pete Wishart: What is the current position of other building societies, are there any other building societies in the position that Dunfermline found itself, are there any others that are about to go to the wall?

Mr Pain: As you will appreciate, Mr Wishart, we do not comment on individual firms and obviously with our primary focus on financial stability you would not expect me to talk about individual firms today.

Q54 Mr Davidson: Can I just follow that up without asking you to comment on individual firms? Could it be said that the collapse of the Dunfermline was predictable? Looking at the figures, looking at the direction of travel, the car speeding along, could you see the wall that they were heading towards or did it come as a complete surprise to you as it did to the driver?

Mr Pain: You cannot divorce those issues, Mr Davidson, away from the economic market conditions as well so what happens in the external marketplace in respect of commercial lending or any other form of lending has a bearing in terms of the risk that any institution might endure, so all those factors are part of that. It is clear and very noticeable that obviously the prevailing economic conditions over that period of time for commercial property were ---

Q55 Mr Davidson: Are there any other mutuals that also hit the wall?

Mr Pain: There are, as a matter of record, a number of other building societies over the course of the last 12 months who have actually merged to a stronger partner in that respect.

Q56 Mr Davidson: They have obviously been more attractive and more saveable, have they not, otherwise they would not have merged with somebody else? What I am just trying to clarify is that this is a uniquely bad situation, is it not, because even though the others got into difficulty they were in overall terms saveable and were indeed saved? This was just so appalling that nothing could be done except picking through the wreckage and taking the bits that could be utilised elsewhere. Is that fair?

Mr Pain: It is probably fair for the Committee also to realise that we worked excessively hard before the final resolution to find a merger partner and in fact three firms undertook full due diligence on DBS to see whether a merger was possible, but ultimately unfortunately that was not the case. We tried to find a range of market solutions for this particular firm.

Q57 Mr Davidson: Were the firms, the potential suitors, offered appropriate dowries to take the wreckage at all? Would that have been a cheaper way of doing it?

Mr Pain: We looked at all aspects in terms of what the possibilities might be for a market solution, if I could use that expression, Mr Davidson, but ultimately they did not come forward with a solution that was viable.

Mr Davidson: Thank you. One of the other issues is that if I could quote from Robert Peston, who is the obligatory source on all these matters, he said that Dunfermline's 2007 annual accounts did not show the extent of its exposure to commercial property and its auditors appeared not to realise the exposure. Is there a problem with the system of annual audit that does not allow for an exposure big enough to send an institution under to be visible?

Mr Pain: The audit requirements for any institution in terms of a building society, including Dunfermline, are laid out in regulations in terms of the Building Societies Act and their published accounts were entirely consistent with those requirements. It is fair to say and maybe fair to clarify in terms of the point you are asking that actually at the point of making those accounts final the auditors are looking at the balance sheet and their known impairments in terms of the portfolio, they are not forecasting the future potential losses, that is not the purpose of the audited accounts.

Q58 Mr Davidson: Robert Peston said, if I may quote directly, "For me perhaps the most shocking element ... is what it has revealed about the uselessness of the 2007 annual accounts. It's impossible to identify in these the size or nature of its exposure to commercial property." You would say that that was not correct there, you would say that the accounts did give an accurate representation of their exposure.

Mr Pain: I am saying that in terms of the requirements of those regulations to report they were entirely consistent and signed off by the auditors as being entirely consistent with those requirements. There is not a requirement to give further disclosures maybe as Mr Peston is referring to; their accounts were entirely consistent with those regulations.

Q59 Mr Carmichael: Presumably there was a fault in the regulations then.

Mr Pain: Not that I would perceive, Mr Carmichael; Mr Peston might have a different view.

Q60 Mr Carmichael: If you have got accounts that do not identify the single biggest problem that is facing the building society, what is the point? What is the point in having accounts if they do not show the true picture? How can people be expected to make informed investment decisions on them?

Mr Pain: As I say the accounts fully reflected the requirements of the regulations.

Q61 Mr Carmichael: The requirements of the regulations but they did not reflect the true position that the building society was in.

Mr Pain: I would stress that those are not FSA regulations, those are enshrined in the Building Societies Act as an Act of Parliament in respect of that, they are not a requirement for the FSA in that respect.

Q62 Mr Carmichael: You have told us that you were issuing warnings, specific warnings, to Dunfermline. You have told us also that you knew what the true position was, you could see the accounts that did not show the true position and you are not seeing a problem with this systemically.

Mr Pain: One of the things that I tried to helpfully explain to Mr Davidson is that the report and accounts show the level of impairment on the balance sheet at the time the report and accounts are struck. The whole purpose of the report and accounts is not to give a forward-looking view but many of the issues that you are referring to in terms of our assessment of this institution are forward-looking in terms of what it was exposed to.

Q63 Mr Carmichael: Surely though the point of this is that somebody who is familiar with this part of the financial services sector would be able to look at the accounts and, if they were meaningful, to make informed judgments on what was likely to happen. That is surely the point of having a balance sheet.

Mr Pain: Sure, but as I say the balance sheet purpose is to show the level of impact at that time. Do not forget that we are talking about 2007 here and many of the issues that we are talking about in terms of eventual loss are at the end of the year 2008 and then forward-looking in terms of the potential risks that were in front of the society.

Q64 Mr Devine: If I am a shareholder and I am a saver and you are sending letters of warning for four years, should that not be flagged up to me in the interests of transparency?

Mr Pain: All the Dear CEO letters and the speeches we made to the BSA and the warnings in that respect, apart from the private warning to a firm which obviously is not public information, are publicly available in that sense.

Q65 So I would know from 2005 that you were sending out warnings.

Mr Pain: I cannot honestly recall - because I was not at the FSA at the time - whether those particular letters were published. It is not our usual practice not to make those public in that sense. Letters to individual firms about individuals, given the confidentiality of those matters, are not matters of public record.

Q66 Mr Devine: From 2005 you know there is a major problem and you are sending letters of warning but there are three or possibly four annual reports saying everything is okay. Three anyway.

Mr Pain: Just for the sake of clarity in terms of what we talked about over that period of time, at 2005 if we go back to the earlier point in terms of where the building society was at that stage the portfolio was at a particular point. Many of the issues that we have talked about were issues that came later in terms of the final issues that brought this institution down. The issues that we raised in terms of 2005 as part of our risk review process of that firm were private to the particular firm itself. The issues that we made over the period from 2004 in terms of Dear CEO letters and warnings to the industry at large were a matter of public record. The report and accounts would reflect the level of impairment and losses on the portfolio at that moment in time but would not have been forward-looking to 2007/2008.

Q67 Mr Devine: Mr Pain, we have got the FSA wrong, have we not? You are the unacceptable face of capitalism in 2009 are you not?

Mr Pain: Sorry, I am not sure I understand your question.

Q68 Mr Devine: Here we have an FSA that is light touch on regulation and we have seen a crash of the banking system right across Britain, and what is being said is that you were aware of those problems years before and nothing was done.

Mr Pain: I have described the actions we take. I do not think nothing was done, we did take action over that period of time and we also, as a matter of public record and reflected in our Chairman's letter to the Chancellor, show that the nature and the intensity of the supervision of the FSA has changed significantly over that period of time but particularly since 2007. I am not trying to rewrite history in that respect; we have acknowledged the fact that that is the case.

Q69 Mr Devine: Lord Turner has said that the FSA plan to issue a new code of conduct.

Mr Pain: As part of our ongoing and increasing intensity across the whole sector, but particularly in terms of the building societies you are referring to, it is our intention that we will be issuing a code of practice later this year that refers to the expectations of systems and controls if building societies wish to diversify their business, tightening up those yet still further.

Q70 Mr Devine: The code of conduct at present and the guidance at present is wrong.

Mr Pain: With guidance you can always improve and reinforce those points and that is what we see the code doing later this year.

Q71 Mr Devine: Will that mean a change in the law?

Mr Pain: No, this is guidance that we will be giving in our handbook, the handbook rules to building societies. It is not going back to the point in terms of the framework of what the building societies are operating, it is not our role to rewrite the Building Societies Act.

Q72 Mr Carmichael: If when you have effected all these changes you find yourself with a building society today that presented the same set of facts and circumstances as that which was presented by the Dunfermline in 2005, what would happen differently?

Mr Pain: It is a difficult question to answer in terms of the conjecture as to what might happen.

Q73 Mr Carmichael: Let me tell you my concerns and tell me if they are addressed.

Mr Pain: What I draw you back to, Mr Carmichael, by way of indication is if you look at the intensity in terms of our activities with this particular firm, which is spelled out in that letter over 2007 and 2008, that shows the level of intensity, so it shows that in fact we would effectively make more interventions in bringing external skilled parties in to review the portfolio. The level of management changes that we encouraged the board to make in respect of strengthening its management team was part of the engagement of the FSA at the end of 2008 with this particular firm, so those are indications in terms of the increased level of supervision that we have now recognised is part of the role of the FSA.

Q74 Mr Carmichael: The warning letters that went which were first of all the general round robin letters, the Dear CEO letters, would they be different?

Mr Pain: It depends obviously on the circumstances. As I said before our focus in terms of individual firms has to be tailored to those individual firms and their particular risks, but it is very clear and it is a matter of public record in terms of the level of intensity of supervision that we now expect to deliver against individual firms.

Q75 Mr Carmichael: The specific warning letters that you sent to the Dunfermline as I understand it effectively constituted reminders about the importance of them carrying out due diligence in respect of those matters in their balance sheet that concerned you, is that right?

Mr Pain: In part.

Q76 Mr Carmichael: What more did they have in them then?

Mr Pain: It is actually understanding the risks inherent in purchasing loans from another source where you have not originated those loans for yourself.

Q77 Mr Carmichael: That is where due diligence comes in surely.

Mr Pain: Due diligence is part of that and also, as you will see from our intensification in terms of stress testing and asking firms to undergo stress testing in respect of their portfolios, that would be a feature of that type of activity. If you are going to acquire a portfolio you think then about stress testing that portfolio to understand what risks might be inherent in that.

Q78 Mr Carmichael: Because it seems to me that you have sent out warnings, you are saying we want you to do due diligence, but at no point have you ever gone back to say to the Dunfermline "We told you to do due diligence, we presume you have done what you were told, please tell us what the results were." Did that ever happen?

Mr Pain: By way of implication in just 2007, as I have already alluded to, when they wanted to purchase a further portfolio, that deal was cancelled.

Q79 Mr Carmichael: You stopped what was going to be the most toxic acquisition but in terms of sounding warnings, taking early action in respect of the toxicity that they had already acquired, nothing really happened.

Mr Pain: I do not think that is right.

Q80 Mr Carmichael: What did happen then?

Mr Pain: As I have already explained and as spelled out in Lord Turner's letter to the Chancellor, if you look at 2005 through to 2008 there are aspects in terms of the interventions we made in 2005 with the further tightening of the controls of the portfolio, there is the rejection in 2008 of the firm's internal capital assessment, which goes back to the risk and the stress testing of the portfolio, and there is the further stress testing we took for all firms, the additional liquidity requirements that we required for all firms throughout the end of 2008. There is therefore plenty of evidence to show, to answer your question, the level of intensity of supervision on that basis, both to this individual firm and to firms across the market as a whole.

Q81 Mr Carmichael: But it still all managed to go horribly wrong.

Mr Pain: In a sense the economic conditions, as I have already said in my opening remarks, in terms of what this firm was exposed to - if the market, particularly the commercial market, takes an appreciable turn for the worst, those assets are already on their balance sheet.

Q82 Mr Carmichael: As the regulator did you allow yourself to think the good times were going to last forever?

Mr Pain: No, what we have talked about in terms of stress testing is an indication that obviously we expect firms to think about what would happen if economic conditions changed.

Chairman: Can we please move on as Mr Pain has to leave at 3.30?

Q83 Mr Davidson: Can I just ask one point about this? In all of this with hindsight do you think you were under-powered?

Mr Pain: In what sense Mr Davidson?

Q84 Mr Davidson: You mentioned earlier on to me about the limits that were there of 25 per cent of gambling as it were that you allowed. Would you not, with hindsight, have wanted to have had more powers so that instead of just sending out circular letters you would have wanted to be able to step in and say, "Look, stop doing that?" What we are trying to do is just identify what could have been done earlier to stop this disaster. I recognise that the main responsibility for the crash lies with the drivers, I understand that, but what I am just trying to clarify is whether or not you should have been able to have taken action, warned them, done something else. Are there particular powers that, had you had them, you would have been able to utilise to stop this disaster happening or was it inevitable? I am working on the basis in all of this that the collapse of the Dunfermline Building Society was not an act of God and therefore there were decisions made by people that led to that collapse. What I am seeking to clarify is whether or not you feel at any stage with additional powers you would have been able to stop it, or was it in some way always inevitable?

Mr Pain: The point I would make would be that obviously the Building Societies Act enshrined the activities and 25 per cent of those activities could be in non-core lending. That is enshrined in the Building Societies Act and it would obviously be a matter for Parliament to decide. It must be remembered that the context of that at that time was to allow building societies in a modest way to compete as financial institutions across the marketplace as a whole and the balance of that was in terms of 25 per cent of lending. There are other firms that have undertaken that without endangering their whole enterprise.

Q85 Mr Davidson: That is a very good point; other firms have involved themselves in diversification without endangering the whole enterprise so clearly the rule itself as it is just now is not sufficient, there will have to be presumably some opportunity for someone to intervene within that 25 per cent and say "Look, this is not appropriate." That presumably is an indication that you do not have sufficient powers to intervene, is it not?

Mr Pain: I believe that with our intensifying level of supervision in terms of what we have already set out since 2008 and post Northern Rock gives us a framework to actually do that. As we have already referred to, in 2009 the code of practice we intend to enshrine in the handbook for building societies will further solidify those controls.

Q86 Mr Davidson: We will not make the same mistakes again.

Mr Pain: Obviously, ultimately, one would not wish to see any firm go the way of Dunfermline, but equally at the same time it is probably impractical to believe that any regulatory environment could avoid any firm, of whatever size, getting into difficulties.

Q87 Mr Davidson: I wonder if we could move on then, Dunfermline was the first to go into the Special Resolution Regime. How well did that work?

Mr Bailey: As I said earlier one of the principal objectives of the resolution regime when we have to apply it - and I can assure you that we all go out of our way to not apply this regime because of the difficult situation that results - is that the depositors in the institution are put into a safe home and have the confidence that that solution protects them and that it can go on as business as usual. As you know, that involved a transfer to the Nationwide Building Society of the deposits and also of the prime mortgages, and there is often in these institutions quite a strong overlap between the prime mortgage borrowers and the depositors so that they in a sense quite naturally sit together sometimes. I can say that so far that objective has been achieved, the whole atmosphere is much calmer around Dunfermline, we obviously look very carefully at the movement of deposits, the outflows and the inflows - there has not been an outflow since then - the press speculation and coverage has died down, which is obviously an important issue for the confidence of depositors, so in that sense we can say, yes, we have achieved the objective.

Q88 Mr Davidson: The other two of you are both happy with all of that and the three parties are working well together and everybody is agreed about the courses of action that were followed.

Mr Pain: We would share Andrew's view that the resolution process worked effectively to protect particularly depositors, both retail and wholesale depositors, which is quite important.

Mr Davidson: Fine, thank you.

Q89 Lindsay Roy: How well is the bridge bank operating?

Mr Bailey: I should have perhaps said at the outset - I am sorry, Chairman, I did not give my full list of titles - I am also currently the Chairman and Chief Executive of the Dunfermline Building Society bridge bank. Perhaps I should start by explaining why the bridge bank. When we looked at the Dunfermline it was evidence that it had a very large, disproportionate to its size, presence in the social housing lending market in Scotland - it is, I believe, the second largest social housing lender in Scotland after the Royal Bank. That was obviously an important consideration in terms of the objectives and making sure that we could stabilise the building society and stabilise the activities that it undertakes. That was a particular reason for creating the bridge bank, which only has the social housing lending in it. We are of course looking to sell it, obviously we are trying to find a buyer for it, and we are - I should stress this - running the bridge bank as business as usual, and I have made this point to the Scottish Executive, to the Scottish housing regulator and to the Federation of Housing Associations, that we have not come in to change the nature of what it is doing, we are running it as business as usual. We obviously want to put good controls around it and, to give you a figure if you like, since the bridge bank was created on 30 March and as it is a wholly owned subsidiary of the Bank of England at the moment, we have advanced, as of last night anyway, £10.2 million of lending to registered social landlords in Scotland, which is all part of the undrawn but committed lines that Dunfermline had. Finally, the bridge bank is advancing the pipeline of new social housing projects that it had on its books coming through at the point when we took it over. Frankly, I and my colleagues are doing all that we can to make sure this is business as usual as we get it ready to be sold.

Q90 Chairman: Are you happy with having the social housing loans in the bridge bank?

Mr Bailey: Let me be clear, as the Bank of England I am not in the market to acquire activities and banking books, but I am happy to have it in the sense that, as I said, it is clearly an important function in Scotland, and that was very evident. It is clearly something that ought to be kept whole and continuous in that sense, so in that sense, yes I am because it was a sensible use of a tool that has been created in legislation that only came into being in February of this year.

Q91 Chairman: Did the Treasury request that inclusion?

Mr Bailey: Given the process that exists to decide upon the resolution, I have to consult both the Treasury and the FSA on what I call the choice of tools. In this case we used several of the tools because there was a transfer to Nationwide and there was a bridge bank, so yes we did consult and yes they were involved.

Q92 Chairman: How do you see the future of social housing lending?

Mr Bailey: I have to say I do not take a long term view on social housing lending because it is a bridge bank and the word "bridge" is important. I have talked to officials at the Scottish Executive and that was very interesting because they gave me a very clear account of the way in which social housing lending operates in Scotland and the intention as towards future social housing lending in the immediate future, so that was very helpful to us. As I said, we are doing all that we can, frankly, to support that in terms of keeping the second largest social housing lender going in a business as usual fashion.

Q93 Mr Carmichael: Can I just ask as well on the point of the bridge bank the information I have is that there are issues about the staffing and the resourcing. You have a very small number of staff who are struggling to service it and to sell it off at the same time. Are you satisfied that you have got the staffing that you need?

Mr Bailey: I was there on Friday - and it is a staff of four essentially. I understand and I am very sympathetic to them that obviously we have placed a large burden upon them because, as we say, we want to run the business as usual. They have all the contacts and the knowledge - we have people there, but they have the knowledge quite clearly - and at the same time we want to get this to a future home which will set it off on a permanent footing. To do that we have got to do all the due diligence process, we have had to set up a whole mechanism for prospective purchasers to do due diligence and, as part of that of course, one of the things that any purchaser wants to do is to talk to the people who know about the business, take their time up and find out. I am very conscious - and it was something that I talked to them about when I saw them on Friday - that we are putting them under strain but trying to do it in a reasonable course of time rather than spin it out is sensible, because the other point that I am very conscious of is that as individuals they want to know what their future is, and this is very important too. They all have, as you will know, long experience in this business and long experience actually with Dunfermline. They are a very experienced team, they have built up a business, clearly, as the second largest lender; they want to know where it goes in the future and I would like to be able to say to them this is Dunfermline's solution and this is your part in it. It is a strain, you are absolutely right.

Q94 Mr Carmichael: You have identified staffing as an issue then, because I have to suggest to you that there is a public interest issue here given the fact that we are dealing with social housing that that bridge bank be managed in a way which is effective. There must be concerns surely that if the staff are struggling to do everything that is required of them they are not going to be doing it effectively?

Mr Bailey: There is a concern and I am concerned about that because I am trying to balance a number of objectives here, and you are absolutely right to make the point that in doing that there is a strain that obviously falls on the staff, so I am trying to balance the objective of continuing to support social housing lending and the objective of finding a permanent home for the bridge bank and, as I said, finding a permanent home for the staff to know what their future is.

Q95 Mr Carmichael: Probably what I am coming to ask you is you have identified the problem; is that something they are just going to have to live with or are you going to do something to make their life a bit easier? In fact, these are not the people who are responsible for the situation in which they find themselves, are they?

Mr Bailey: No, they are not. I said to them last Friday when I was there, "Look, we have put resources in but I do not have resources who are experts in social housing lending in Scotland, I will be absolutely honest with you on that." One thing I said to them, to be very clear, was: "You can get in touch with me personally if we are causing you an unnecessary burden. I will be honest with you, we are putting some more controls around the whole operation, I will be quite clear with you on that; if we are doing things that you think are unnecessary, tell me."

Q96 Mr Carmichael: And their concerns about their pension future and the rest of it, the final salary scheme, that is clearly something which is a legitimate and substantial concern for them.

Mr Bailey: Exactly.

Q97 Mr Carmichael: Are you able to offer them any reassurance?

Mr Bailey: I can offer them the reassurance that we will endeavour to find the best future for this operation and for them that we can. They are all very committed, they all want to be part of this future and that is a great credit to them by the way.

Q98 Mr McGovern: The Government has been, perhaps understandably but in my view disappointingly, reluctant to give us exact details of the potential losses to the taxpayer from the use of the special resolution regime. Are you in a position to tell us now what exposure the taxpayer now has in this regard?

Mr Maxwell: I can talk through how the exposure arises and the nature of that exposure. As we discussed earlier, the Treasury provided roughly £1.6 billion to fund the transfer of the retail deposit book to Nationwide; consequently, that makes the Treasury a creditor in the administration process and one would expect there to be a very significant recovery from the winding-up of the estate as part of that process. The other thing is that the losses through this process will firstly be borne by whatever reserves are that remain in Dunfermline's business and, secondly, by the Financial Services Compensation Scheme. Under the Banking Act, to which Andrew referred earlier, the FSCS is liable to contribute to the cost of this resolution up to the level of the costs that it would have accrued if there had been a straight liquidation or administration of the society, so it is liable up to those costs. The Treasury is liable for certain types of costs over and above that.

Q99 Mr McGovern: I do not know if your microphone is not working but I can barely hear you, I do not know if everyone else is in the same situation.

Mr Maxwell: Shall I go through it again?

Q100 Mr McGovern: No, just continue.

Mr Maxwell: That is it; that is the process by which the costs and the liabilities will be dealt with.

Q101 Mr Davidson: I had difficulty hearing that and it would be valuable if you would just tell me again. How much has this actually cost the Government because at the beginning of our briefing part of the note it suggests that some had argued that the Government could have saved Dunfermline with £100 million and the Scottish Executive - unfortunately Mr Wishart has now left and he would be able to tell us a better figure - it was suggested would be able to find £25 million that would solve the problem in some way. Can you just tell us exactly how much the Government has put into this?

Mr Maxwell: The Government has proved about £1.6 billion in funding.

Q102 Mr Davidson: Sorry, can you say that again?

Mr Maxwell: £1.6 billion of funding.

Q103 Mr Davidson: That is quite a lot more than the amount that the Scottish Executive were able to find.

Mr Maxwell: But that is funding. We will not know the costs to the taxpayer until the end of that administration process and, as I say, the first part of any losses will be borne by the capital that was in the Society, the second part of any losses will be borne by the Financial Services Compensation Scheme up to the amount that they would have borne if the society had simply gone into administration or liquidation and then the Treasury would be on the hook for certain costs beyond that.

Q104 Mr Davidson: And we have no idea how much those sums cumulatively could conceivably be. What is the worst cost of all options in terms of liability to the Government?

Mr Maxwell: I do not think this is something we can speculate about; we need to wait to see how that administration process works. There is a large buffer there in the form of the Final Services Compensation Scheme.

Q105 Mr Davidson: How could grown-ups suggest that £100 million would actually have saved all this? What I do not quite understand is the juxtaposition between these huge figures that you are mentioning that it has actually cost and the suggestion that we were hearing earlier on at the time of the crash that for what sounds like loose change the whole thing could be saved? Are we comparing apples and apples?

Mr Bailey: This is not a comparison, this is an apples and oranges thing. I mentioned earlier that the key thing about the resolution was to put the depositors into a safe place. In order to do that there has to be substitute funding to match the assets that are being left behind, and that is the number that Clive has quoted which is around about £1.4 billion, but that is not the same as the numbers that have been quoted of £60 million, £100 million, more than that, all sorts of numbers, which relate to what you think the eventual losses would be once this whole story has unfolded. That is quite a different number, so in other words the replacement of the funding to allow the depositors to be put into a safe home, you would expect to get that money back because there is not that big a hole in the balance sheet. What we do not know and we cannot know until, as Clive has said, the process of completing the winding-up of the administration is done, is exactly what the final loss will be. One of the reasons we do not know that is because of course it will depend on how the economy and economic circumstances unfold during the time in which this administration process is undertaken, and it will also therefore depend upon decisions that the administrator will have to take - that is KPMG - in consultation with the Creditors' Committee, in which process the Government and the FSCS will be parties, and on just how quickly therefore they do propose to wind this thing up. They can obviously take decisions about the scheme and that will influence the eventual outturn.

Q106 Mr Davidson: I just want to be absolutely clear about this because none of us are trained bankers or anything, but those who were saying that this could all be saved, all be sorted, for £60-£100 million, effectively that was nonsense then, was it not, because you would have to have somebody behind that with enormously deep pockets in order to provide the sorts of guarantees that you are indicating were necessary.

Mr Bailey: Again, it comes back to this problem of apples and oranges. The question of could it be saved for £60 million, could it be saved for £100 million, could it be saved for something more depends critically on what level of capital provision to support future losses would have created the confidence that the problem was taken care of under a sensible set of outcomes as to where the economy will go and where the value of the assets in the Dunfermline Building Society will go. All those things are the critical determinants of where this thing eventually runs out, but as I said earlier to give confidence - and confidence is the critical thing here - it would have taken a number in terms of the provision of capital which gave the message clearly to the depositors, frankly gave the message clearly to all of you and to the press, this problem is taken care of, we do not need to worry about this one any moiré.

Q107 Chairman: Mr Pain, we will probably finish the whole thing in the next ten minutes but if you want to leave now you can leave with our thanks.

Mr Pain: Thank you, Chairman; if it is ten minutes I am more than happy to stay and help the Committee.

Q108 Chairman: I am sure we will finish everything in ten minutes. Can you tell us what impact is there going to be on jobs? Will head office staff be retained?

Mr Maxwell: Firstly, as part of the transaction agreed with Nationwide the 500 or so DBS staff in branches transferred to Nationwide on 30 March and as part of that deal Nationwide has agreed that there will be no compulsory redundancies in the branch network for a minimum of three years - that is quite a useful reassurance about the stability of the situation for those members of staff.

Q109 Mr Carmichael: Can I just follow up on that and come back to the question I asked Mr Bailey about the pension fund which is in administration. Of course, that goes well beyond the bridge bank across the staff as a whole; what is the position for the wider staffing vis a vis the pension fund?

Mr Maxwell: All existing Dunfermline employees were transferred to the Nationwide. Eligible employees are going to be offered membership of the Nationwide personal pension arrangements.

Q110 Mr Carmichael: What constitutes eligible employees, is that the ones that have transferred under TUPE or what?

Mr Maxwell: I would have to check the details of that I am afraid.

Q111 Mr Carmichael: You do not know what constitutes eligibility in this context.

Mr Maxwell: Not the precise details of that.

Mr Carmichael: It would be helpful for the community and indeed for the staff themselves if that sort of point could be clarified.

Q112 Mr Davidson: Could I just clarify, in terms of the numbers what is the balance between eligible and non-eligible? Is it 50 per cent in each category or 90 per cent in one and ten per cent in the other?

Mr Bailey: The substantial majority are eligible but the safest thing is that we write to you about that.

Q113 Chairman: There is a criticism by some that the Government saved the big banks and the big institutions and on the other hand in respect of building societies of a smaller size the Government failed to act. What is your assessment of this as there are widespread concerns on this issue?

Mr Maxwell: The Government has approached all of these issues in relation to different institutions through those three criteria that I referred to earlier about protecting financial stability, protecting depositors and protecting the taxpayer, and it has looked at all of the situations through those three criteria in coming to its decisions about how to act. In respect of particular schemes like the recapitalisation scheme they have again particular criteria that have been used to assess the eligibility of individual institutions.

Q114 Chairman: Are you sure that the size of the Dunfermline Building Society did not have any bearing on the Government not rescuing it?

Mr Maxwell: Clearly one of the big issues here was about the sustainability of its business model going forward and the significance of the losses it was making as a proportion of its balance sheet, for example, so in that sense the size of the losses relative to the size of the institution was a factor in those sorts of decisions.

Q115 Mr Davidson: Can I just clarify that? Compared to HBOS or compared to the Royal Bank of Scotland the size of Dunfermline's losses as compared to its overall size were greater, is that what you are saying?

Mr Maxwell: What matters is the fact that the size of the extra capital that was required made it, according to the assessments we have just discussed, unrealistic to expect it to remunerate any extra capital that was put into the business to fill a gap that size.

Q116 Mr Davidson: Was that different from the Royal Bank of Scotland then?

Mr Maxwell: Yes, the Government was taking different forms of ownership stakes and returns from those institutions,

Q117 Mr Davidson: I just want to be clear. Notwithstanding the point that there are different forms of ownership stakes I am just trying to clarify whether or not the Dunfermline Building Society was in an even worse state than the Royal Bank of Scotland or whether or not it got less advantageous treatment either because it was Scottish or because it was small. If you can tell me that in words of one syllable it would be helpful.

Mr Bailey: Maybe I could answer that first of all. Clive has made the point that we had to take a judgment on whether the Dunfermline was going to generate sufficient future income over a period of time to support any injection.

Q118 Mr Davidson: I understand that, that was one of the few things I did understand. What I do not understand is whether or not it was worse in terms of its financial position than the Royal Bank of Scotland. That seems to me to be a pretty straightforward question to which you should be able to give me a yes or a no.

Mr Bailey: The answer to that is that the Royal Bank of Scotland is in a position where there is reasonable expectation that it can earn sufficient income in the foreseeable future that it can service the provision ---

Q119 Mr Davidson: That is a yes then, it was worse.

Mr Bailey: That is a yes.

Q120 Mr Davidson: Fine, thank you.

Mr Bailey: Let me also make one other point because a point about size was made. Bradford and Bingley was an institution that was, to my memory, more than ten times bigger than the Dunfermline so it is not a question of very small institutions go one way and everybody else goes another way.

Q121 Mr Davidson: And Bradford and Bingley was worse than the Royal Bank of Scotland as well was it?

Mr Bailey: Yes.

Mr Davidson: Thank you.

Q122 Mr Carmichael: Can I clarify that the clarification I am seeking in respect of the pension fund is the final salary pension scheme.

Mr Maxwell: I will check that. My colleague just passed me a note to explain that the Government ministers have already written during the statutory instrument debate explaining the pensions of DBS and have placed a copy of that letter in the library of the House, but I will make sure that this Committee gets a copy as well and I hope that will answer your question.

Q123 Chairman: Can I thank the witnesses for their attendance. Before I declare the meeting closed would you like to say anything in conclusion perhaps on areas which have not been covered during our questions?

Mr Maxwell: No thank you, Chairman.

Chairman: Thank you very much once again.