The meeting ended with the question of the extent of the Bank’s responsibilities:
The Governor expressed his concern about the trend towards more consumer protection legislation. In the banking industry it was leading to the expectation that banks would never fail. Finance was a risk business. The degree of protection given to customers, however, was a political judgement. The Bank’s role was to point out that there were two sides to the regulatory ledger. Mrs Lomax agreed. She said regulation was increasingly governing the relationship between a bank and its customer, but the Bank’s real interest was in minimising systemic risk. Mrs Lomax asked whether, if the Bank wished to avoid retail regulation, it would wish to supervise only big banks. The Governor said systemic problems could well start in small banks. The issue was the scope of supervision.
All of which was manifestly sensible and proportionate, but of course, out there in the global financial world, the pieces kept moving. ‘Good progress is being made in capturing and confining the risks which arise from derivatives operations,’ Quinn in July 1994 reassured the Annual Managed Derivatives Industry Conference in New York. ‘The supervisors and regulators in the main centres are working hard in specialised groups to find solutions that deliver regulation without strangulation. Perhaps equally important, the market is developing its own form of safeguards by insisting on greater disclosure and transparency, improved accounting rules, collateralisation and margining requirements that protect both them and the ultimate users of the product.’ And he concluded that ‘the earliest apprehensions about derivatives have been replaced by a methodical analysis of the possible sources of difficulty’.41
Yet should the Bank still be undertaking banking supervision? In the twin context of BCCI and the gathering independence debate, that was becoming by 1993 an increasingly asked question. Taking evidence that year, the Treasury Select Committee heard some views arguing in the negative. ‘The problem about having supervision,’ reflected Sir Peter Middleton (former permanent secretary at the Treasury, now deputy chairman of Barclays), ‘is that it detracts from the Bank’s credibility as a counter-inflationary body because people will always think it is more interested in maintaining the banking system than it is in pursuing its own counter-inflationary objectives’; according to the former chancellor, Lord Lawson, another financial scandal like BCCI could ‘undermine the respect and authority of the Bank of England in the eyes of the financial markets and public opinion in general, and this respect and authority is important to the successful conduct of monetary policy in the real world’; while even Quinn conceded that ‘if the central bank as supervisor gets a sustained hammering in the public domain for its activities there, then that cannot help the authority of the institution’. In November, well aware that the Treasury Committee was considering its report, George used the second of the governor’s LSE lectures – a year after Leigh-Pemberton’s important one on price stability – to press the case that the close, two-way interdependence with monetary stability meant that the preservation of financial stability was inevitably a matter of close concern to a central bank. Moreover, he implicitly argued, no one could do it better:
The central bank has a vital duty to support the soundness of the financial system. We are clear about our objective: it is not to prevent each and every failure, but to ensure that, when a systemic threat arises, it is dealt with quickly and efficiently. We have the ability to do this because we know a lot about all the institutions and markets through which threats can materialise. We get our information largely from the process of supervision – from being a direct supervisor ourselves, and through our involvement in the markets, and through our contacts with other supervisors at home and overseas. And, in our central banking role we have the resources to do this job – not just money, but also the technical skills to manage out difficult positions, and the reputation for impartiality which enables us to co-ordinate commercial solutions.
The following month, the Treasury Committee more or less agreed that the Bank should not go down a Bundesbank-style road. ‘On balance,’ stated its report, ‘we conclude that there is no overwhelming case for separating out the responsibility for prudential supervision to a separate body’; and the report added that this was likely to remain its view ‘even if the Bank gains greater autonomy in monetary policy’. That, however, was far from ending the debate. ‘A super supervisor?’ was the Economist’s headline in May 1994, noting the publication of a paper from the Centre for the Study of Financial Innovation with a double proposal: the Bank to give up its supervisory role, concentrating instead on monetary policy; and a super-regulator to be created, known as the Financial Services Supervisory Commission. For the Bank’s 250 supervisors, overseeing the operations of 488 domestic and foreign-owned banks in the UK, the premium on ‘alertness’ merely grew by the day.42
Such was the state of play at the point of the tercentenary, and in the event the next financial scandal, intimately affecting the Bank, was not long in coming.43 ‘Peter Baring, Andrew Tuckey and Peter Norris met the Deputy Governor, Mr Quinn, Mr Foot and Mr Reid on Friday 24 February at 12.00 pm to make them aware of a major problem in Barings’ Far East operation which had emerged over the previous 24 hours,’ recorded the deputy governor’s office in early 1995. ‘Mr Baring said that if the group survived, it would need substantial recapitalisation,’ while ‘Mr Tuckey noted that the rest of the business was in very good shape.’ In essence, the unwelcome news that the men from Barings imparted was twofold: first, that a Barings derivatives trader, operating from the Singapore futures exchange (SIMEX), had run up huge, fraudulent losses, possibly of at least £400 million; second, that Barings itself – after an impeccable, blameless 105 years since the previous Barings crisis (governor Lidderdale and all that) – was in deep trouble. George had just left for a skiing holiday in France, but at once flew back. On Saturday morning, he spoke to Derek Wanless ‘to ask if NatWest were interested in buying Barings’, but ‘Wanless said the answer was no’; he then ‘asked if NatWest might be prepared to put up some equity along with others’, to which ‘Wanless said it would depend on the deal.’ George and his colleagues then spent most of the day arranging for a mixture of clearing bankers and merchant bankers to assemble at the Bank on Sunday the 26th to see if any collective rescue could be arranged of the City’s oldest merchant bank, if no longer its most important. The deadline set for any rescue was 10 pm that Sunday – before the Japanese market, in which most of Barings’ positions were open, began trading again.
An epic day unfolded, mainly in Threadneedle Street but including occasional gubernatorial forays outside. At the first, calling on the chancellor around lunchtime, George took the line that although it would be ‘a big shock to the markets’ if Barings were not bailed out, nevertheless the risk in his judgement was not systemic – to which Clarke agreed. Would Barings be bailed out? As early as mid-morning, David Scholey was observing to the governor, after a lengthy meeting of the proposed consortium of supporting banks, that ‘as the positions were so big and as they were open-ended, it would be very difficult to finalise the deal’. Essentially, that remained the case throughout the day and into the evening. Meanwhile, hope flickered that the Brunei Investment Agency might perhaps be willing to cap Barings’ liabilities – before eventually at around 8.30, an hour and a half before the deadline, the news came through that Brunei was unable to help, on the understandable grounds that the envisaged deal was ‘too complicated, involving too much risk and with too little time’. By 9.45 the governor was at No. 11, informing Clarke that it had proved ‘too complicated’ to try to save Barings in the time available. They agreed that George should appear on the Today programme at about 7 the following morning; and the governor said that he would emphasise ‘the control failure’.44
Next day, George duly gave a round of media interviews insisting that the problem was specific to Barings and that that bank’s failure posed no systemic threat to the banking system as a whole. Should the Bank have d
one more? William Rees-Mogg in The Times on Tuesday thundered about its ‘grotesque timidity’, arguing that it had ‘avoided risking at most a few hundred million pounds’, whereas ‘the credit of London, which has been put in jeopardy, may be an unquantifiable asset, but it must be measured in hundreds of billions of pounds of Britain’s future earning power’. He concluded gravely: ‘The Bank of England exists to protect British credit. In this instance, it has failed in its prime duty.’ The same paper’s Graham Searjeant and Anthony Harris took a similar line, as did its leader writer; but John Plender in the Financial Times persuasively countered the Bank’s critics:
It is, of course, a case of mistaken identity. A City whose good name has been so dreadfully traduced no longer exists. London’s competitive advantage in international finance has little, if anything, to do with the older cohorts of the merchant banking fraternity who financed world trade in the 19th century. For the best part of two decades the powerhouse of financial innovation has been located largely in the foreign banking and securities community …
Moreover, he added, ‘in the absence of a club, successful lifeboats are not easily launched’. By the end of the week there was widespread agreement that George had got it right. ‘The external impact of the crisis has so far been successfully contained, vindicating the decision not to rescue Barings,’ the Independent noted on Saturday, while next day the Sunday Telegraph’s Bill Jamieson argued that ‘if the impression got around that domestic banks could be counted on to be bailed out by their central bank, that would suggest a playing field so tilted as to drive out every non-resident bank’. And, he asked rhetorically, ‘where would the City be then?’45
By this time, not only had the ‘rogue trader’, Nick Leeson, been identified and remanded, but a buyer, the Dutch bank ING, had been found for Barings, priced at an attractive £1. In the course of that process, George firmly declined an invitation from ING’s advisers, Flemings, either ‘to take on the risk of any potential subsequent claims from SIMEX or the Japanese’ or ‘to pick up (in an indemnity fashion) some form of capped liability in relation to possible claims from Tokyo and Singapore in order to give their client comfort’; but quietly and behind the scenes the Bank did take on Barings’ swap exposures and some custodial responsibilities, as well as providing liquidity for ING to acquire Barings. A fortnight or so after the main drama was over, George spoke – at length and privately – at the annual dinner of the Cornhill Club, a City-based dining club. ‘It has been a torrid time,’ he acknowledged. ‘Emotions have understandably run high and a good deal of uncertainty has been generated.’ Why had the Bank ‘been unable to orchestrate a rescue by the rest of the banking community’? The answer, he asserted, was not any waning influence on the part of the Bank, but rather because commercial banks ‘do not easily act against their perceived commercial interest just because the Bank of England asks them to’. ‘That probably always was true,’ he added. ‘It certainly is true. And long may it continue.’ Why, then, did not the Bank ‘ride to the rescue itself’, in other words as lender of last resort, or ‘persuade the Government to do so’? ‘No financial institution has a right to support,’ the governor declared. ‘It is deliberately intended that there should be constructive ambiguity about whether or not in any particular situation we would be prepared to support any particular institution. If that weren’t the case, and any institution felt that it was guaranteed, then that would introduce, of course, a great deal of moral hazard into the monetary system.’ Accordingly, given that the specific ‘solvency problem’ faced by Barings was in the Bank’s judgement ‘unlikely to have very major systemic risks’, he and his colleagues ‘could see no basis for suggesting to the Government that they should write the blank cheque that would have been necessary to produce the cap on the liability’. And, he went on, ‘whatever you may read in some newspapers, the knock-on effects were in fact both limited and short-lived’. George finished by looking ahead: ‘The shock of Barings’ failure will take time to pass. But in the end the reputation and the prosperity of London, and of the British banks operating out of London, will depend much more fundamentally on the quality of the services which they provide.’46
He was speaking on Thursday, 16 March. Three days later, a Sunday tabloid’s lurid, but in the circumstances irresistible, headline – ‘The Bonk of England’ – was accompanied by the revelation that a journalist, Mary Ellen Synon, had been smuggled into the Bank under an assumed name and that she and the deputy governor had made love on the carpet of the governor’s dressing room. Briefly it seemed that Pennant-Rea might survive, as the quality papers temporarily declined to touch the story; but then the Financial Times gave it a seven-column splash, and very soon the deputy was penning his resignation letter. ‘Montagu Norman,’ he reflected, ‘once said that “the dogs bark, but the caravan moves on”’ – though quite what the great defender of the Bank’s honour would have made of it all rather beggared belief. Brian Quinn briefly stepped in as acting deputy governor, until the appointment of Howard Davies, director general of the CBI and already in his mid-forties a man for all seasons, having worked previously in the Foreign Office, the Treasury, McKinsey and the Audit Commission. An almost absurdly classic meritocrat – son of a publican; Manchester Grammar School; Oxford – he had been, he told Ruth Kelly in an interview for the Old Lady before he took up his position in September 1995, ‘circling round the Bank for the past twenty years’.47
The Pennant-Rea episode was particularly ill timed. The Bank’s decision not to bail out Barings may have been vindicated, but there remained the troubling, high-profile matter of whether in the first place it had been negligent in its supervisory capacity. In early April, barely a month after the spectacular collapse, George faced aggressive interrogation from the Treasury Committee’s Brian Sedgemore about how subsidiaries of Barings had lent £330 million of Barings’ own funds to Baring Futures in Singapore:
Am I not right in thinking that if you transfer the whole of a company’s shareholders’ capital, the Bank of England has to be notified?—The Bank of England has to be notified as a matter of law if a company wishes to advance more than 25 per cent of its capital to a single counterparty.
My question, Mr George, is this: were you notified?—We did not know as of 27 February that [£330 million] was advanced this way.
So effectively you are saying to the Committee quite honestly that you have a supervisory system which is incapable of informing the Bank of England that a sum in excess of the whole of the shareholders’ capital has been transferred out of the country. Is there not something wrong with the supervisory system?—We do not know day by day the details of every exposure taken.
We are talking about rather a lot of money, Mr George, in relation to the size of the bank.—Of course we are, but how can we be certain to know about the large amount of money unless we are monitoring every day the small amounts of money? It is a criminal offence –
Or unless the internal or external auditors tell you. It is a criminal offence …?—It is a criminal offence not to inform us; to advance this money without notifying us.
Three months later, in July 1995, the Board of Banking Supervision – of which the majority of members were independent of the Bank – issued a report acquitting the Bank of culpability over its ignorance of the transfer of substantial funds from London to Singapore in the early weeks of the year and asserting that the Bank had ‘reasonably placed reliance on local regulators of the overseas operations’, as well as having been ‘entitled to place reliance on the explanations given by management as to the profitability of these operations and on the other information provided by Barings’. The Bank, in short, could not have prevented the collapse. The report did offer some constructive criticism – recommending that the Bank should ‘go further in its role as consolidated supervisor’ and ‘should seek to obtain a more comprehensive understanding of the non-banking businesses in a group’ – but broadly was viewed as being something of a whitewash; or, as th
e Financial Times put it, of being ‘woefully soft’ on the Bank.
The day after the report’s publication, George and Quinn gave evidence to the Treasury Committee. Chris Thompson, the senior manager in charge of merchant banking supervision, had resigned ahead of the report, but the two men were adamant that the Bank, whether by commission or omission, had done little or nothing seriously wrong, while George did not hesitate to raise the emotional temperature. After conceding that such was ‘the intrusive British press’ that he now found ‘extremely tempting’ the proposition that ‘if your reputation in the monetary policy area is damaged by every failure in banking supervision, you would be better off without it’, he turned to the fundamentals of the supervisory role itself:
George: I am sure I have said to this Committee before that if you wanted us to guarantee no banking failures, frankly I think we could have a shot at that and we could give you a guarantee. It would mean that everybody’s deposit had to be matched by a government liability of precisely the same maturity. Of course the bank could not make any money on that basis and of course it would not do the economy much good, but you have to understand and I am very anxious to really persuade you of this point that there is a trade off, there is a balance that has to be struck between the extent of regulation and the cost of regulation in a direct sense but also in terms of the effect it has on the ability of the financial system to support the wider economy. So you cannot say to me, ‘You shouldn’t care about that at all. All you should care about is stopping banks going bust’. If you meant that, you would not have provided deposit protection in the Banking Act. You clearly recognise that there has to be some kind of balance. We do not have any clear guideline on whether it is acceptable for one bank to go bust every 20 years and whether it is a bank of £5 million or £5 billion. These are judgements which are actually intrinsic. You can say to us that we must do better. You can say to us we must spend more money. You can say to us we must introduce more restrictions. All I say to you is that you look on the other side and say, ‘What is going to be the effect?’ I am in full flood now so if I may just make one other point because it is absolutely tremendously important to us as well as to you, and that is that actually getting able people to do this job is becoming damn difficult. Mr [Nicholas] Budgen was asking whether or not we should be getting new people into the Bank to do this kind of thing. How on earth do you think we are going to get people in to come and do this kind of lose-lose job when we go through this kind of procedure every time there is a problem? I do not resent it. I understand precisely that this is the way –
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