UK: TESTING TIME FOR THE OLD LADY - BANK OF ENGLAND NEEDS TO EXAMINE ITS OPTIONS.

UK: TESTING TIME FOR THE OLD LADY - BANK OF ENGLAND NEEDS TO EXAMINE ITS OPTIONS. - The Bank of England is under attack and now is a good time for it to examine its options, writes Shirley Skeel, before it, too, needs a rescue.

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Last Updated: 31 Aug 2010

The Bank of England is under attack and now is a good time for it to examine its options, writes Shirley Skeel, before it, too, needs a rescue.

A long drop down from the grand corniced ceilings of the Bank of England, the small Scot, Brian Quinn, sizzled in his armchair, itching for a fight. It was being said his Governors job was on the line over the BCCI bank scandal. There were sniggerings of political interference, and cries from the Press condemning the stately Bank's 'delay' in shutting BCCI's doors.

These were no small allegations and Quinn, an executive director in charge of banking supervision, was not the kind to dodge them. But at the Bank of England, confidentiality is king. The Bank, he said curtly, had its reasons. The Press's notion of even a sniff of politics was sheer nonsense'. And if you wanted to call it a delay, you should just try being in the good Bank's shoes. 'We got what we got when we got it. And we did what we did when we did it,' Quinn snapped, referring to the secret Naqvi files that revealed the fraud at BCCI. 'And if you're asking me if I sleep at night, I don't have any trouble.'

A spare, lively man with every line on his face drawn together by wickedly amused eyes, Quinn was so swamped by the leather chair it was curious to see his tooled leather shoes flat on the carpet.

Surprisingly, he had not the lofty, virtuous manner that one expects of the Bank of England. He is bluntly frank about the depth of the mud at the Bank's doors.

Would he agree the Bank's reputation was badly damaged by the BCCI scandal? 'It's under attack, that's unmistakable,' Quinn frowns. 'But I'm happy to wait until Lord Justice Bingham (who is inquiring into BCCI) reports. Does the BCCI disaster suggest the Bank needs greater powers? Quinn hastily points to the international nature of BCCI and its lack of a single regulator, but concludes with candour, 'I'm as yet unclear as to whether a stiffening of legal power is necessary. If it is necessary then we'll seek the authority of parliament for it.'

BCCI is too big a scandal for claims of a political subplot not to have arisen. Once news broke of early Price Waterhouse reports of deceitful accounting, of the involvement of British intelligence, and of a missing warning memo to the Department of Trade and Industry, the Opposition was on the attack, demanding that the Prime Minister explain. Bank of England Governor Robin Leigh Pemberton quickly covered for John Major, saying he was told of the fraud at BCCI only days before it was closed. Some find this difficult to believe, and claims have been made that the Bank of England purposely delayed in shutting BCCI because of political fears that it would harm relations with our ally Abu Dhabi during the Gulf War. One former Bank insider says he would near stake his life on it that politics did not come into it.

But the Bank's claim of untainted independence would be easier to defend if it could claim a whiter-than-white past. Sadly, it can't. The extent of the suspicion that exists was plainly shown in September when the Governor gave his first upbeat report on the economy. The Opposition roared that it was sheer party politics to speak so during a time of election fever. Rightly or wrongly, the Governor was compromised.

At least one clear example of political interference does exist to support such suspicions. It all started with Eurotunnel, a Government pet project that proved to be a devil to finance. Only because Threadneedle Street blatantly pushed the project on the City, did it survive. One banker recalls ruefully that his institution twice refused pleas for loan money from the project's lead bank because the returns were too uncertain. 'But it then got to the Bank of England's ears and evidently there was a phone call from the Governor to our chairman and we caved in. They leaned on the banks, there's no doubt about it. And the banks didn't like it.'

Another banker recalls 'serious pressure' not only from a major clearing bank that was assigned the job of raising money, but from the DTI - confirming that there was a political hand at play. But, despite such testimonies, the Bank steadfastly denies any political motive. In a stately office pinned with modernist paintings that he had the luxury of choosing himself (most directors get portraits of dead bankers or grazing cows), Bank of England associate director Pen Kent prefers to find higher reasons for the Bank's actions over Eurotunnel. 'It is true that the Bank took a close interest in the early rounds. We wanted there to be an efficient flow of capital, and it may be that when you start to get demand for such long-term, large projects you need some collective thinking. We do encourage constructive outcomes where we can see that there is some apparent market imperfection.'

Kent, a tall, languid man who could well find a second career in the theatre, manages to say all this without flinching. Indeed. So he thinks the bankers' reluctance to finance Eurotunnel was a mere market aberration? Alas. One can almost hear the bankers' sighs of resignation.

Mind you, not everyone pays heed to the Bank's well intended proddings anymore. It is widely acknowledged that the old 'nod and a wink' from the Governor, or 'moral suasion' as it is known, does not work like it used to. In the last decade the number of banks in London has ballooned to 530 - forcing them to cut margins and take on larger risks. Today their own survival is paramount. The interests of UK Ltd run a poor second.

A potent recent example of such self-interest was that of British and Commonwealth Merchant Bank (BCMB). Standing in the shadow of John Gunn's collapsed British and Commonwealth group in May 1990, BCMB was nonetheless still solvent, and hopes were high that it could be saved. Several gentlemanly meetings were held at the Bank of England with leading banks to seek a refinancing for BCMB.

Three of the banks, Midland, Standard Chartered and Lloyds, refused to play along. Evidently they thought they could gain more by seeing BCMB dissolved and the assets moved upstream to the failed parent group which already owed them money. 'They dug their heels in. I think the Bank of England was quite surprised,' one participating banker reports. The story in the City - denied by the Bank - was that the then Midland chairman Sir Kit McMahon (himself an ex-Deputy Governor of the Bank of England) and a Standard Chartered senior executive were soon after summoned to Threadneedle Street. Regardless, nothing changed.

Quinn demurs that this was hardly a 'failure' of the Bank as they were not out to save BCMB. 'We didn't try to persuade people to take on risks which they, after careful consideration, judged they shouldn't.' The case, he says, served as a timely warning to depositors and other banks. 'We knew in our bones that if we failed to support the organisation that it could mark quite a change in atmosphere. People would say, "My God, we thought the lender of last resort was always there to support institutions that were solvent but not liquid." But if we saved BCMB we would create the presumption that we would always do it. Then you risk creating many more incidences.'

The judgment to be made, he says, was whether BCMB's closure would have a serious knock-on effect on the banking system. 'Our judgement was that it wouldn't, and so far we've been right.' In a broader context however, Quinn concedes that the Bank's moral suasion powers have indeed diminished. 'In the good old days when it was easy to make money, it was easy to invite banks to reach an understanding. It's a lot harder now.'

The Bank maintains it is clear in its own mind just when it will or will not apply pressure to save a bank - the last time was Johnson Matthey in 1984, when fears of a gold market collapse sparked the Bank to action. An embarrassing political furore followed - possibly contributing to the Bank's current 'hands off' stance. But, as fate would have it, this attitude too is creating enemies.

Soon after the BCCI was shut down, the small lender, National Home Loans, ran to the Bank of England, fearing a run on its branches from depositors who were deserting the fringe banks. In this one case the Bank was able to find several lenders to provide back-up finance - but only because there was an attractive margin in it.

The Association of District Councils meanwhile pleaded with the Bank to set up a lifeboat for all smaller banks, so public confidence could be restored. Rumours soon followed that the Bank was indeed urging big banks to pass liquidity on to the small. The Press reported that the big banks were refusing, because, as one banker says, 'Why put money into some small bank that could go to the wall?' The fact is, the Bank of England says, they did not act at all. 'We are no longer in the game of trying to press people to act against their commercial judgement, Quinn says. Instead the Bank had kept a watchful eye.

Luckily, so far, smaller banks have not started sinking into the mire. But with markets as nervous as they are, the Bank could be accused of playing a dangerous game. The Bank says it believes in free market forces. Some prefer to call it the law of the jungle. If smaller banks did start folding, it would spark a vicious political storm.

True, it is a fine line the Bank treads. But it is hard not to get nervous over a distinct leaning in the Old Lady's posture. This is most obvious when it comes to company rescues. In the 1980-81 recession not one major British company failed, as the Bank was quick to press lenders to show sympathy. The Bank even had 35 companies under its own wing. Today, collapses are frequent, and though up to a dozen companies at a time may be given some 'hands off' attention, as one broker says, 'The Bank doesn't give two hoots about them.'

George Blunden, Deputy Governor of the Bank from 1986 to 1990, says he worked on the basis that the Bank should intervene 'if the company is viable and looks to be something that should be saved'. Pen Kent, who now oversees company rescues, takes a harder line. 'The relationship between banks and companies is their business,' he insists. 'We're not just an accident ward that sends out ambulances.' Kent says the Bank will act as a forum for talks, but it will not apply pressure. 'We don't try to pick national champions or say we must have a maker of widgets in the UK.'

This appears quite a radical change of attitude. And it coincides with a time when banks are forcing liquidations more aggressively than ever. Surely questions must be asked. Is this a healthy state of affairs? Are too many viable firms going down? Should the Bank do more? And can it? It is worth noting when asking this that the Bank is not quite so coy about applying pressure as Kent suggests. At Brent Walker, the initial refinancing ran into a serious hitch in July when several of the 47 banks refused to take part. Three of those resisting were Banque Worms, Kyowa Bank, and the Chuo Trust and Bank. It was later reported that Chuo was talked into the deal by the Bank of England. A small Japanese voice at Chuo Trust responded to our query on this with, 'We have no comment, thank you. No comment,' and a click of the receiver. But another observer reports, 'There was a little bit of subtle hosting of a meeting at the Bank where I think the Japanese banks found it not unhelpful to have the Bank signal "it would be a good idea if.."' It is said that after a call from the Old Lady to the French and Japanese central banks, the others fell into line.

Pen Kent's ever-active hands brush aside any suggestion of 'pressure'. He gives an example of 'disinterested help' as an afternoon when two warring camps were 'sitting around the table, so tired they were falling asleep in front of me. I took them to separate rooms...and discovered their absolute bottom lines. Then I could say, I know that this camp can't shift, so it's up to you to decide whether the other side will now join the majority or bring the company down.' Similarly, the Bank has helped parties to 'talk sense' at Laura Ashley, Coloroll and Ferranti.

A number of controversies-over the Blue Arrow affair, Harrods Bank, and now BCCI - have not made these final two years of Governor Leigh- Pemberton's term easy ones. He also had a rough start in 1982 when the City derided him as a 'Thatcher poodle'. But soon after bankers reported a refreshing new openness at the Bank. Described as 'that sort of Englishman who tends to hide high intelligence', Leigh- Pemberton stuck his oar into government monetary policy often enough to win respect - although critics still accuse him of lacking vision. His deputy, Eddie George, in the running for his seat in 1993, is unanimously voted a 'very very clever man'.

In organisational terms, the Bank's supervisory arm is impressive. The 200-strong supervisory team operates off Threadneedle Street in a plethora of gothic-windowed rooms, spotted with computers and lined with rough manila files. Insiders say the transition from a service based hierarchy to a meritocracy is well under way. 'The cream settles at about the right place,' reports one. Staff members meet with each bank's management and auditors several times yearly. Random bank visits are also made and information exchanged with the police and Serious Fraud Office.

The troubles at BCCI, and the inquiry into the affair, present a timely opportunity to review the Bank of England's role. If Leigh- Pemberton gets the flack for BCCI, he may well claim the shortcomings to be in the law or in public understanding - not in his judgment. Bankers, at least, seem sympathetic. 'Everybody in the world likes to find a scapegoat,' grumbles one.

But, BCCI apart, questions remain on the Bank's vulnerability to party politics; on the rising failure rate of moral suasion; and on the best approach to bank and company failures. One option is a more strictly legal system, as in the US. As one banker describes it, with distinct anathema, 'You argue your case here and the Governor raises his eyebrows and you do it. In America you go to your lawyers and they say you don't have to and you don't.' This approach is notorious for benefiting few, bar the lawyers: it would not go down well here. But the options for Britain are many. And it is not too early to start mulling over them. For, if BCCI gets really ugly, the next bank rescue job could be at Threadneedle Street itself.

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