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Saturday 11 October 2008

How to rescue a bank: be firm, be quick, be quiet

Ian Hay Davison draws lessons for the handling of the Northern Rock crisis from his experience as chairman of National Mortgage Bank after its collapse in 1992

Third, NMB was never put into administration. Instead, stringent restrictions were placed on it as the price of support from the Bank. This had the effect of ensuring that depositors did not suffer as they would have done had insolvency law been followed.

National Home Loans was — like Northern Rock — a quoted company subject to Stock Exchange rules, and therefore an announcement had to be made to the market as soon as the Barclays syndicate was set up. But the fourth difference between this and the Northern Rock case was that a convincing solution could be presented at the same time as the problem was publicly acknowledged.

There are other important points of contrast. The first is size. The amount of central bank support for Northern Rock is far larger: not £500 million but as much as £100 billion. Part of this is due to the sheer increase in the scale of personal borrowing over the past 15 years, part to the rampant inflation in property values and the size of mortgages after a period of very low interest rates. The NMB case was forecast to cost the Treasury a sum approximately equal to the Bank of England’s profit for one year. If the outcome of Northern Rock is a £5 billion loss — which is not unlikely — that would be 80 times the NMB figure. But the mechanics for handling the matter are not affected by its size, and the problem is not so large that it requires entirely different techniques.

The second point of contrast has to do with politics, always present in such cases. It was unfortunate that the run on the Rock happened just as the Prime Minister was deciding whether or not to go for an autumn election. Not surprisingly, given the importance of Northern Rock in the Labour stronghold of the North-east, the government was extremely disinclined to take a strong line. In the NMB case, a strong line was taken but politics was never allowed to become a driving factor.

My experience at NMB leads me to draw three conclusions from the mishandling of the run on the Rock. The first has to do with speed. Usually (if that word can be used about an event as rare as a run on a bank), the matter has been resolved and a clear way forward announced within a week; there was no problem about not keeping shareholders informed, creating a false market or offending the Takeover Code. But in Northern Rock’s case the saga lasted six months — and is not over yet.

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