Government considers legislation to prevent another Northern Rock crisis

30 January 2008 / by Rachael Stiles
The Treasury has announced that the Government will be proposing new legislation which will give the authorities more power, enabling them to intervene if a bank looks likely to fail, in order to prevent another crisis like the one that befell Northern Rock.

A 12-week consultation is currently underway which will discuss methods of improving the current system to better preserve financial stability and protect depositors.

The new legislation will mean that a special resolution regime will be triggered when a bank is seen to be getting into difficulty; it will also give authorities the power to appoint a restructuring officer in exchange for emergency support.

The move comes in response to criticism aimed at the Bank of England, which some say sat back and watched as Northern Rock fell further and further into a liquidity void, borrowing up to £28 billion in emergency funding from the Bank as it struggled against the effects of the American sub prime mortgage crisis.

The existing tripartite regulatory system will remain in place, it is thought, with the Treasury in charge of the overall framework, monetary policy will continue under the domain of the Bank of England - whose Governor Mervyn King has today been re-appointed for a period of five years when his present term of office expires on 30 June 2008 - and the Financial Services Authority will remain in its supervisory role. Ultimate responsibility will still lie with the Chancellor of the Exchequer or finance minister.

Northern Rock's director, Paul Thompson, is pushing for an in-house solution to its crisis, which would see Northern Rock continuing as an independent company; he will meet with shareholders later this week to put forward his case, but there are concerns that this option would see the mortgage lender cut to half its size, increasing the likelihood of job cuts.

It could, however, prove cheaper than one of the other possible alternatives – a take-over by the Virgin Group – which would involve Virgin charging the struggling bank as much as £10 million a year for the privilege of using the Virgin brand name. Additionally, any private sector sale would have to get over three main obstacles first: getting Government approval backed by the European Commission in Brussels, acquiring shareholder approval, and raising sufficient equity to recapitalise the bank.

The Government's answer to the Northern Rock question would be to refinance the Bank of England loan by turning it into Government-guaranteed bonds which would then be sold to investors.

In light of the Northern Rock crisis, ongoing liquidity shortage, and growing fears about a recession, investors withdrew the highest amount in history from investment funds in December, making the last quarter of December the worst on record for the investment industry and further exacerbating the credit crisis.

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