Credit crisis: regulatory and fi nancial systems reform
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SPOTLIGHT
KEY POINTS
National and international financial markets have been subject to fundamental Spotlight
restructuring since the early 1970s. Important lessons have been learned by all parties
from the recent crises and certain areas for regulatory correction identified.
Necessary amendments must be adopted as quickly as possible, although care must be
taken not to overreact or over-regulate. Effective crisis resolution in future will principally
be dependent on better informed and timely judgement having regard to the new financial
and risk conditions that apply.
Author George Walker
Credit crisis: regulatory and financial
systems reform
Attention has focused in recent George Walker reviews the recent crises in financial markets with the tightening of
months on the credit crisis as it credit on the interbank markets and the Northern Rock support facility, as well as
expanded over the summer and the forced the more general challenges that remain to be resolved in national and international
support of Northern Rock on 14 September markets at this time. This was written before any of the details of the legal advice
2007. Following resolution of the immediate given to the Bank of England or the reviews subsequently conducted by the Treasury
crises, attention focused on the allocation of or Financial Services Authority (‘FSA’) were released.
blame and recrimination with regard to the
handling of the rescue operation at Northern
Rock and subsequent injection of liquidity advances in computer hardware and software particular, for the Federal Reserve (which
into the money markets. These events were supported the cross-border expansion of became the main ‘umbrella’ supervisor)
nevertheless not isolated and only reflect financial activity during the 1980s. The although underlying sector separation
larger, more fundamental, changes that have ‘Big Bang’ in London in 1986 (following was still largely preserved in US domestic
taken place in financial markets in the UK New York in 1975) represented a further markets. Many other countries including the
and globally in recent decades. significant step in the creation of a truly UK have moved to the adoption of a more
global international financial marketplace, integrated approach based on a combination
MARKET CHANGE AND EVOLUTION especially with the move to electronic price of ‘single markets’, ‘single regulators’ and
National and international financial quotation and then dealing, as well as the ‘single rulebooks’.
markets have been subject to fundamental abolition of earlier restrictions on dual
restructuring since the early 1970s. Financial capacity market making, fi xed commissions MARKET RESTRUCTURING
institutions have had to operate in a new and foreign ownership. All of these developments have to be
environment dominated by market, currency While banks had originally led the considered against the significant underlying
and interest rate instability (especially
following the collapse of the Bretton Woods
system of management exchange rates "Debt has increasingly been issued in a security
between 1971 and 1973). Many of the new
off-balance sheet instruments used by banks
rather than loan-based format."
and financial institutions to manage risk
including all of the main types of financial
derivatives were created and the main US expansion of cross-border financial activity changes that have been taking place in
derivatives exchanges opened during this from 1958 onwards (with the post-war financial markets in recent times. These
period. Financial crises did occur, such restoration of currency convertibility), have principally been associated with
as with the secondary (fringe) bank crises securities firms were able to follow during the parallel processes of securitisation,
in the UK in 1972-73 and the closure of the 1980s. Further consolidation then took disintermediation, innovation, repackaging
Franklin National in the US and Bankhaus place during the 1990s with the construction or restructuring and the separate
Herstatt in Germany over summer 1974. of increasingly large complex groups made ‘privatisation’ of debt.
Despite these events and the severe oil price up of core banking, securities and insurance Debt has increasingly been issued in a
surges during 1973/74 and 1979, growth was functions. This process culminated in the security rather than loan-based format due
substantial principally driven by overseas US with the adoption of the Financial to the advantages of transferability and lower
expansion, deregulation especially of capital Competitiveness Act 1999 (Gramm Leach funding costs available. (The international
controls (beginning in the UK in 1979 but Bliley) and subsequent creation of Citigroup syndicated loan market collapsed by a
quickly spreading elsewhere) and increased from City Bank and Travellers. The creation factor of four between 1975 and 1985 while
market integration more generally. Massive of financial holding companies (‘FHCs’) in the bond market grew by an equivalent
improvements in telecommunications and the US was a significant achievement and, in proportion.) Many bank or loan based
Butterworths Journal of International Banking and Financial Law November 2007 567SPOTLIGHT
Spotlight
credit instruments have also been further through the use of internal order books at financial risk especially with the growth
‘securitised’ by being sold off in packages to major investment banks. Rather than use in repackaged and structured products.
special purchase vehicles (‘SPVs’) in return open regulated markets on a continuous Traditional risks (including, in particular,
for new bond or note issuances. Underlying basis with the higher transaction costs credit risk, market risk and interest rate
loan or credit based claims have then been involved, internalisers only go to the market risk) have been broken up into securitised
transformed or converted into transferable to balance their net positions at the end of ‘tranches’ which are then rated and sold
securities. There has also been a substantial each trading day. into the market separately. This has led to a
‘disintermediation’ of finance with many fundamental fragmentation of financial risk
corporate and government borrowers NEW MARKETS and distribution or dispersion of exposure
increasingly issuing their own debt directly These changes have lead to the emergence across the market place. Total or aggregate
into the market principally through short- of three particular new market sectors risk has not been diminished or diluted but
term commercial paper. Investment banks with the substantial expansion of the simply divided (arguably disguised) and sold
or specialist advisers assist in setting the alternative investment market (‘AIM’), and, on. Financial risk is split up (segregated),
programmes up but once established the in particular, the growth of hedge funds graded (rated) and then traded rather than
issuers can manage their own funding and private equity as well as the creation of actively managed.
positions on a revolving and continuing basis. a whole range of new structured products
With this, longer ten- to 15-year bonds or based on the further repackaging and trading SUBPRIME MARKET
debentures have increasingly been replaced of debt and financial risk. The vulnerability of the structured finance
by shorter three- to five-year ‘notes’ and then Almost 9,000 hedge funds have been market was revealed with the deepening of
even shorter commercial paper issues (of established since Alfred Winslow Jones’ the subprime mortgage problem in the US
possibly less than 30 days or up to one year). original long and short (fully hedged) fund earlier this year. It is estimated that up to a
Capital market debt has then become shorter in 1949 with the industry now managing quarter of the subprime loans granted could
in duration and simply rolled over in the same US$1.6trn in assets. The private equity go into default, with homeowners losing
manner as in the money markets. market is now estimated to be worth over their property. Two million early fixed-rate
A large number of new types of financial £432bn, with more than 684 specialised mortgages were expected to be reset with
instruments have been created following management vehicles arranging over 29,000 US$100bn of new adjustable rate polices
earlier forward contracts and financial deals in aggregate and generating £3.3bn in coming on stream. Much of the blame for
derivatives. These initially consisted of swaps fees per year. this was placed on aggressive sales practices
and traded futures contracts. The use and Structured finance can be considered by unregulated brokers, excessive and
complexity of options grew substantially and to include more traditional securitisations, inopportune lending by banks and other
culminated in the most recent explosion in the although the new structured finance market credit providers as well as the provision of
use of credit derivatives including total return is now dominated by such instruments as false credit information by many borrowers
swaps (‘TRSs’), credit spread swaps (‘CSSs’) collateralised loan obligations (‘CLOs’), often using self-certificating disclosures.
and credit default swaps (‘CDSs’). There has collateralised bond obligations (‘CBOs’) and A number of reforms have since been put
also been a substantial amount of ‘repackaging’ other collateralised debt obligations (‘CDOs’). forward by various political and regulatory
of debt subsequently with the replacement of CDOs are based on an underlying financial groups in the US. These include establishing
existing credit relations with more complex instrument (which may include an already a $1bn fund to support the most needy
arrangements tailored to produce specific securitised product) rather than a pool of borrowers and the federal regulation of
payment or risk profiles for individual asset receivables as with more traditional state-monitored mortgage brokers (which
institutional investors or groups of investors. securitisations. This then constitutes a had arranged 50 per cent of the subprime
This securitisation, disintermediation particular type of repackaging where the loans). More extreme options include fining
and innovation and repackaging has been assets consist of a portfolio of securities rather unscrupulous lenders and imposing liability
associated with a further privatisation than loan or credit assets. Structured products on subsequent purchasers of mortgage-
of equity and debt markets. Many listed also include credit linked notes (‘CLNs’) backed bonds. All of this would simply
institutions have found that cheaper sources which combine a fixed income security with raise the level of litigation risk in the US to
of funding can be obtained through private an embedded credit derivative. Some $250- further heights and dry up the subprime
placements or ‘introductions’ rather than 300bn structured notes are issued each year. lending market which was intended to assist
full public offerings. Huge over the counter borrowers with qualified credit histories
(‘OTC’) markets have emerged in recent DECONSTRUCTION OF FINANCIAL to purchase property within their means.
years, especially in the financial derivatives RISK Congress should avoid another Sarbanes-
area. A related more recent phenomenon has All of these changes have been accompanied Oxley style over-reaction as occurred following
been the ‘internalisation’ of market trading by a more fundamental ‘deconstruction’ of Enron’s collapse.
568 November 2007 Butterworths Journal of International Banking and Financial Law
SPOTLIGHT
Spotlight
The problems with the subprime market CREDIT CONTAGION funds from Northern Rock, the Chancellor
have since spread globally due to the initial The US subprime problems spread to the of the Exchequer announced on Monday 17
securitisation of the subprime loans being UK and other national markets with the September that the Treasury would support
incorporated into more complex CDOs. drying-up of credit on the interbank markets. all of the bank’s deposits and that the same
Fifty-six per cent of all US residential As the larger operators in the money markets facility would be made available to all other
mortgages were securitised, including up became increasingly concerned about each equivalent lenders running into similar
to two-thirds of the subprime market. other’s possible exposures and the potential difficulties at that time.
Securitisation has brought significant extent of the losses that may be suffered by While the Bank’s position with regard
advantages, especially in terms of lower costs smaller institutions (as well as their own to both interbank liquidity and individual
of borrowing for consumers, release of capital contingent liabilities), banks decided to bank support can be explained in terms of
for banks and higher earnings for investors. retain rather than on-lend surplus capital. the 19th-century rules used, the threat of
The deconstruction of risk with CDOs and This led to the freezing-up of all of the contagion had been aggravated by the extent
similar instruments is meant to spread risk main interbank markets across the world. and non-transparent nature of the potential
and consequently the ability of the market While the European Central Bank (‘ECB’) losses that may have been suffered by other
to absorb loss. It is nevertheless unclear who and the Federal Reserve began to inject financial institutions (especially on subprime
holds the debt at any point and the extent of liquidity from 9 August onwards, with instruments) and the power of modern
their possible loss. This is aggravated by rating other central banks following, the Bank communications to dramatise the queues
failures (with rating agencies having been paid of England refused to intervene initially of depositors withdrawing their funds. Two
by commission on the debt issued) and with for ‘moral hazard’ reasons (to avoid being other relevant factors were the apparent
the effects of changes in market conditions on seen to compensate banks for previously inability of the general public to trust the
the risk parcels involved. inappropriate practices). Funds were made original statements issued by the Bank and
A further specific difficulty that arose available to individual banks through the the Treasury on behalf of the government, as
with the subprime debt was that much of this Bank’s standing emergency loan facility well as the apparent expectation that no saver
was sold on to funds looking for high returns although only on penalty terms (including should be allowed to suffer loss in any case.
including structured investment vehicles a 6.74 interest rate and full high-quality Opinion still differs as to whether
(‘SIVs’) and specialised off-balance sheet bank collateral). The Bank has used this facility Northern Rock deserved to have been
‘conduits’. These conduits would invest in high- over 14 times this year. The Bank had set out supported. As a solvent institution with
return structured products funded through its arguments against further intervention good collateral, the Bank could not object to
the issuance of short-term commercial paper. in a written statement to the Treasury. This providing a credit line (under traditional LLR
Most conduits (apart from some in Canada) effectively restated its understanding as to theory). The more difficult question is the
were supported by credit lines from their how its traditional financial stability and extent to which Northern Rock’s vulnerability
parent banks which creates significant potential ‘lender of last resort’ (‘LLR’) responsibilities was created by its reliance on interbank credit.
contingent liability. A number of other which had been developed during the early The bank’s impressive performance history
institutions suffered substantial loss in this 19th century would apply in this case. had been generated by aggressively selling
market including two German landesbanks, mortgages using funds largely borrowed on
IKB Deutsche Industriebank and Sachsen LB. NORTHERN ROCK the wholesale markets. Only 28 per cent of its
Many of these instruments were also The event that the Bank did not predict loans were supported by incoming deposits.
purchased by hedge funds which suffered was the run on Northern Rock after its It has to be accepted that this is a legitimate
during the early turn in the subprime market. request for support on 14 September business model as it only makes full use of
Bear Stearns had to close two of its structured 2007. Following early discussions and available facilities on the interbank and other
credit funds. (One had lost 23 per cent of its the breakdown of a possible acquisition wholesale markets. The total UK ‘funding gap’
value over a four-month period after having (by Lloyds TSB), the Bank had agreed to is estimated to be in excess of £530bn ($1trn).
leveraged its $600m capital ten times over provide a short-term credit line that would The FSA is expected to look at the extent to
with Stearns, having subsequently being cover all of Northern Rock’s immediate which more stringent controls could be placed
forced to dispose of $4bn worth of securities liabilities. The specific terms of the support on gearing (borrowing) ratios and liquidity
in an untidy fire sale.) Other hedge funds were otherwise unspecified. Despite the especially in distressed situations.
(including structured credit funds and support announced, depositors continued to
quantitative equity funds) lost substantially, withdraw funds from Northern Rock with LIQUIDITY SUPPORT
although others profited from the more recent concerns arising with regard to the position Despite its earlier resistance, the Bank
crisis including a reported £1bn in the short of other mortgage lenders including, in of England announced on 19 September
selling of Northern Rock stock (which fell particular, Alliance & Leicester and Bradford 2007, two days after the culmination of the
from £12.50 to £1.94). & Bingley. Following a further withdrawal of Northern Rock crisis, that it would inject
Butterworths Journal of International Banking and Financial Law November 2007 569SPOTLIGHT
Spotlight
additional funds into the London markets. REGULATORY RESPONSE to be transferred immediately to a separate
The Bank confirmed that it would provide A number of calls have since been made for account for distribution among depositors.
up to £10bn on three-month terms secured reform of the system of bank supervision and This is apparently available to the Federal
against less substantial collateral. The first control in the UK. It must be stressed that Deposits Insurance Corporation in the US
auction of three-month money was held bank supervision is now conducted within and UK FSCS could be given equivalent
on 26 September, although there were the larger integrated system of financial powers. This would nevertheless only protect
no takers partly due to a recovery in the market control set up under the Financial residual cash balances at the bank (which
markets but also to the perceived stigma Services and Markets Act 2000 (‘FSMA’) may be exhausted before closure anyway).
attached. A number of banks had also and that its revision cannot be considered in Even if a substantial amount was available,
obtained funds earlier in the week through isolation from other markets. this would not cover all outstanding deposit
an equivalent ECB offer. While the auction Following the crisis, proposals for reform liabilities, with depositors having to be paid
was not taken up, commentators argued initially focused on the compensation limits out on a proportionate basis. This may be
that it was its announcement that had led available to bank depositors under the FSCS. quicker than under the current compensation
to a stabilisation in market conditions, The Treasury has been considering increasing scheme, although not necessarily more secure
although the effect may be to question the current limits up to £100,000, although or generous.
further the judgement of Mervyn King, the fees will then have to be increased and the With regard to regulatory practice, the
Governor of the Bank of England, in not corresponding securities and insurance limits immediate focus of attention must be on
acting earlier. reconsidered (as the separate sub-funds reviewing the existing liquidity rules provided
The Governor was called on to explain involved are effectively managed on a common for under the FSA’s Prudential sourcebook
the change in the Bank’s position before basis). Under the FSA’s compensation (‘PRU’) within Block 2 of its Handbook. The
a Treasury Select Committee meeting on (‘COMP’) sourcebook, the schemes currently new sourcebook was issued earlier this year to
Friday 21 September with Sir John Gieve, provide for bank depositors to receive up to create an integrated set of financial and related
Deputy Governor and Head of Financial £31,700 in the event of closure (100 per cent systems and controls rules for all financial
Stability and Paul Tucker, Head of Markets. of the first £2000 and then 90 per cent of the institutions replacing the earlier separate
The decision was claimed to have been next £33,000 in each account) with customers interim prudential rulebooks (‘IPRUs’)
‘carefully designed and judged’ having regard of failed securities firms receiving £48,000 maintained for banks, building societies,
to the strain that had been placed on the (100 per cent of £30,000 and 100 per cent of investment firms and insurance and life
banking system following the Northern £20,000). Insurance policy holders can be companies. This also implements the revised
Rock run. The events had confirmed that paid up to 90 per cent of the value of a long- capital adequacy rules for banks produced by
confidence in the banking system had been term policy or 100 per cent of a valid claim on the Basel Committee on Banking Supervision
shaken which had changed the balance of a compulsory policy or 100 per cent of £2,000 in June 2004 (Basel II) and the corresponding
judgement against extending liquidity. The and 90 per cent on the remainder on a non- EU Capital Requirements Directive (‘CRD’)
Governor added that it would have been compulsory policy. These limits can be easily for loan book capital and re-cast Capital
impossible to inject sufficient liquidity reviewed and increased as necessary. Adequacy Directive (‘CAD’) for securities and
earlier to avert the Northern Rock crisis. Separate calls have been made for the other trading book capital. This will also give
The Bank had become aware of the problem establishment of an insurance-based scheme effect to the equivalent risk-based ‘Solvency II’
with Northern Rock on 14 August following similar to that operated in the US which rules for insurance companies.
which its position was closely monitored. A would allow earlier payment and up to 100 Liquidity is generally managed on a
private sector solution had been attempted in per cent of any claim on a de jure or de facto maturity mismatch basis (Liquidity Mismatch
co-operation with the FSA. basis. This has been rejected in the past in the or ‘LM’ in the Handbook), although sterling
Mervyn King explained that he would UK on moral hazard grounds. This would liquidity may also be managed under a stock
have preferred to have supported Northern also involve a fundamental overhaul of the approach where appropriate (‘LS’). LM
Rock in a more covert manner, although this existing UK arrangements and inevitably measures a bank’s liquidity by assessing the
was not possible under the revised rules given require considerably higher fees which would mismatch between its inflows (of assets)
effect to under the EU Takeover Directive be resisted. It is more likely that many of the and outflows (of liabilities) within different
and Market Abuse Directive (‘MAD’) as well deficiencies identified especially in terms of time bands in accordance with a maturity
as with the freezing of bank accounts under limits and speed of payment can be dealt with ladder. Recommended guidelines are set for
the Enterprise Act 2002. The Governor through revision rather than full replacement maximum percentages. It is clear that the
also questioned the operation of the bank of the current UK system. guidelines can be easily revised, although the
deposit scheme operated under the Financial A separate suggestion has been to provide regime operates on the underlying assumption
Services Compensation Scheme (‘FSCS’) as for the statutory isolation of funds in the event of properly functioning credit markets. More
administered by FSCS Ltd. of a bank’s closure which should allow monies substantial amendment may then be required
570 November 2007 Butterworths Journal of International Banking and Financial Law
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including through the use of stress testing and corrected as matter of urgency. A European of Understanding (‘MOU’) on Financial
contingency planning, failing which separate Commission representative has already Stability had been entered into between
additional capital requirements may have stated that the Commission considers that the Bank of England, the Treasury and the
to be considered although this is arguably necessary concessions were already available FSA on 22 March 2006 which replaced
unnecessary and should be resisted. under the MAD which would have allowed an original MOU in 1998. The terms of
Other requests for greater disclosure and delayed disclosure of a possible rescue having the relationship between the authorities
transparency will almost certainly be adopted regard to such ‘legitimate interests’ as an can be reviewed and their respective roles
especially with regard to the use of off- imminent closure of the bank (art 6). This clarified. This does not, however, require the
balance sheet investment vehicles (including could then be clarified within the FSA’s abandonment of the MOU outright. The
SIVs and conduits) as well as contingent Market Conduct sourcebook ('MAR') in crisis did not arise because the system for
liabilities and other off-balance sheet items. Block 2 of the Handbook. The incorporation discussion and co-operation did not work
This information should already be available of corresponding exemptions should also be effectively. All of the necessary meetings
in the consolidated regulatory returns and possible within the City Code or Companies and discussions had been held. It was simply
statements produced by all of the major UK Act 2006 (to the extent necessary or not that the decisions taken did not have their
financial institutions. Greater emphasis already available). This could all be effected intended effects at certain key stages in the
may nevertheless have to be placed on more by statutory instrument as required. A evolution of the crisis. The issue is then
regular reporting and the degree of detail legitimate complaint is why these issues were one of timing, discretion and judgment
provided (including through the use of special not identified and corrected previously. The rather than of any more fundamental failure
notes as appropriate). other EU issue not referred to is whether in the infrastructure as such. Important
With regard to subprime mortgage sales the support provided constituted a state aid improvements can still be made in the
in the UK, the FSA had already considered requiring notification. This will have to be drafting of the MOU with the establishment
this in an earlier report published over the confirmed separately. of the special crisis monitoring and
summer. This confirmed that while no The insolvency rules as applicable to management unit referred to on which the
erroneous sales had been made as such, banks will also have to be reviewed and all Bank and FSA would co-operate.
weak practices were revealed in a number of residual inconsistencies and contradictions One recent proposal has been for the
institutions. This will have to be corrected and corrected. This does not necessarily mean that MOU to provide expressly that the Treasury
the FSA has already issued guidance in this a separate bank insolvency regime has to be should have the ultimate decision taking
regard. Enforcement action will also be taken created as this may then have to be extended power in all cases and on all matters.
following some of the review cases examined. to other financial institutions under the Considerable care has to be exercised in this
Reference has been made to the need for FSMA. Appropriate corrections could still regard. It is the proper responsibility of the
regulators to focus on the most successful as be adopted as necessary. The FSA should also Bank to assist with and provide advice on
well as worst performing institutions. This consider co-operating with other agencies financial stability, while the FSA is responsible
was perceived to have been one of the failings in the preparation of a special sourcebook for the authorisation and supervision of
with Northern Rock. This is unlikely and on bank and other financial institution individual financial institutions. Both
Northern Rock should have had its own insolvency. Consideration should also be institutions must work together on all
line manager or supervisor within the FSA. given to the establishment of a dedicated crisis matters of common interest and on financial
The authorities were also already fully aware monitoring and support team to the extent crises specifically (paras 13 and 14 of the
of the problems that can arise with high not already in place within the FSA (or Bank). MOU). The Treasury cannot replicate these
gearing levels and low deposit cover. The The immediate task would be to confirm functions, nor should it act in any way that
main problem that arose was the freezing-up that all necessary powers of intervention may undermine their proper discharge by
of interbank credit which none of the risk were available and to establish appropriate the Bank or the FSA. The Treasury should
models used by financial institutions had consultation and reporting arrangements have no operational responsibility in these
predicted could occur as an imminent or with all other relevant departments within matters (as currently provided for under para
likely event. The FSA will already have been the FSA and externally. The unit must also 5 of the MOU). This may otherwise have the
taking these issues into consideration. This be given all necessary resources and ability to effect of ‘politicising’ the whole of the financial
can also be more clearly incorporated into collect information and act as required in any market oversight and regulatory process
the FSA’s operating systems, impact grades, particular case. within the UK. This could also undermine
common risk assessment processes and revised the highly successful policy and operational
ARROW framework. INSTITUTIONAL REFORM independence conferred on the Bank in 1998
The separate statutory difficulties The tripartite relationship between the on monetary and related matters.
referred to with the operation of the takeover Bank, FSA and Treasury has also been This also creates significant moral hazard
rules and market abuse provisions must be strongly criticised. A revised Memorandum problems especially with regard to the extent
Butterworths Journal of International Banking and Financial Law November 2007 571SPOTLIGHT
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Biog box
George Walker is professor in International Financial Law at the Centre for Commercial
Law Studies, Queen Mary, London. He has written extensively in this area and has been
following recent events as they have unfolded. Email: gwalker@ccls.edu
http://www.law.qmul.ac.uk/people/academic/walker.html
of the cover announced by the Chancellor with the management of EU monetary policy Of more concern, is the absence of any co-
in the Northern Rock case. This went by the ECB and the system of central bank ordinated support function.
considerably further than in any previous governors. The need for and existence of the The more general credit crisis has also
event with extension of the facility to cover Bank itself may then become questionable. lead to other increasingly remote effects
any equivalent institution. It was estimated If the Bank is to retain a financial stability such as a review of the nature and value of
that Northern Rock’s guarantee could have function, this will have to be closely the LIBOR system and the establishment of
potentially cost the Treasury up to £49bn, coordinated with the FSA and the effects of a new committee to consider the operation
although the extension could have covered any more general market or individual support of the ultra-safe covered bond market. The
the whole of the UK deposit base of £1,350bn assessed with regard to its likely effects on effectiveness of modern risk management
or £1,600bn (including building societies). monetary policy. techniques (including the use of value at
Financial regulations would then have had to Of possibly more concern than the risk, ‘VAR’, modelling) is being re-examined
have been revised to restrict the activities of effectiveness of the UK MOU is the absence with other aspects of Basel II and the EU
financial institutions to such an extent that of any meaningful co-operation mechanism capital reforms. National central banks and
almost no risk would have been generated. both within Europe and globally in the event regulatory authorities across the world are
This would wholly undermine financial of an organised support operation for a major reviewing the impact of the crisis on their
innovation and the open and liberal markets international bank being required. On the same markets and systems of market control.
that the UK has traditionally supported. day that the Chancellor announced the open
The Chancellor, through the Treasury, support for Northern Rock, it was reported FINANCIAL CRISIS AND EFFECT
will have final authority under the MOU in that EU finance ministers and central bankers We live in a new financial world dominated
deciding whether to act and the extent of any had again failed to agree any detailed rules to by integrated and interdependent markets
particular support to be provided. This should deal with the collapse of a major European within which geographic and sector
nevertheless still proceed on the basis of the bank. Some common general practices for boundaries have collapsed. Continuing
informed advice provided by the Bank and the managing cross-border financial crises were financial innovation, growth and expansion
FSA in any particular case. The MOU can be agreed at the meeting in Porto on 15-16 have allowed financial institutions to
clarified but it should not be abandoned or September, although no agreement was secured generate larger profits than ever before. These
fundamentally altered. on funding arrangements or cost allocation. processes must be supported at the same
Significant criticism has also been made Forty-six major cross-border banking groups time as excessive risk taking is contained and
of the tools available to the Bank under the operate in the EU, 21 of which have significant further financial crises avoided.
current LLR arrangements. The Bank does operations outside their home country. Despite The UK is host to some of the most
have a full range of mechanisms through Commission pressure, it was agreed that a complex and sophisticated financial markets
which it can provide support assistance as ‘flexible’ approach would be adopted in any in the world. This is something that the
necessary. The difficulties that arose again particular case. The Bank of England faced City of London and the rest of the UK are
were not with regard to any fundamental the same difficulties during the early 1970s correctly proud of. The UK also has one of
internal or inherent flaws that require some as the City of London attracted all of the the most modern and advanced integrated
new mechanism to be adopted. The necessary major overseas banks. The Bank attempted regulatory systems with the FSMA, the
measures were available. It was simply that to deal with the problem through informal FSA and the FSA’s Handbook of Rules and
the earlier decisions taken did not have their but unenforceable statements of support Guidance. Important lessons have been
intended consequences with further action from parent banks. This remains a significant learned by all parties from the recent crises
having to be taken as the situation evolved. problem for the Bank, with almost all of the and certain areas for regulatory correction
This is again a question of judgment and major financial institutions in the world having identified. Necessary amendments must be
assessment rather than fundamental systems some form of operation in the UK. adopted as quickly as possible. Care must
replacement. Further clarification of the One unfortunate consequence of the nevertheless be taken not to overreact or
nature of the facilities available and their Northern Rock episode is that this will over-regulate.
terms of operation may nevertheless be made strengthen calls within Europe to centralise The underlying economy and basic
available in future. financial market supervision and control. systems in place are essentially sound.
One further proposal is to take This must be resisted on both subsidiarity Effective crisis resolution in future will
responsibility for financial rescues from the and efficiency grounds as well as the need for principally be dependent on better informed
Bank of England and transfer it to the FSA each system of national regulatory control to and timely judgment having regard to the
with a necessary credit line. This would reflect local market conditions and preferences new financial and risk conditions that apply,
largely undermine the financial stability as at present. Co-operation and contact can rather than through the strict application
function of the Bank with its monetary be further improved, although this does not of substantial new legal or regulatory
competences already significantly curtailed require full centralisation of function as such. obligations and reforms.
572 November 2007 Butterworths Journal of International Banking and Financial LawYou can also read
