New law would allow secret bank rescues

LONDON (Reuters) - The government could provide emergency loans in secret to ailing banks under a proposed law that would give the authorities more power to intervene to prevent another Northern Rock-style crisis.

A Northern Rock in London, September 15, 2007. The government will propose new legislation to give the authorities more power to intervene in the case of a failing bank to prevent another Northern Rock-style crisis, the Treasury said. REUTERS/Luke MacGregor

The government on Wednesday launched a 12-week consultation on improving the framework to preserve financial stability and protect depositors should a bank fail.

The proposals include allowing a bank to keep emergency loans secret for a short period, in contrast to Northern Rock, whose announcement that it had needed emergency funding prompted the first run on the deposits of a UK bank for over 140 years as savers panicked.

“ELA (emergency liquidity assistance) may be a very short-term solution for a solvent bank and immediate disclosure could, by leading to a loss of consumer confidence, exacerbate any liquidity problems,” the consultation document said.

“In these circumstances, there may be strong arguments for delaying disclosure until the temporary problems have passed.”

The document also said in the event of an institution getting into trouble, triggering a special resolution regime, the authorities would have the power to appoint a restructuring officer in exchange for emergency support.

The proposals in large part follow measures set out by a parliamentary committee over the weekend, although they fall short of creating a new financial stability job at the Bank of England.

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However, the central bank’s remit in ensuring the stability of the financial system would be formalised to ensure this aspect of its work is beefed up.

Regulators have come under fire over the crisis that engulfed Northern Rock in September, after it was unable to raise funds in financial markets and forced to borrow about 26 billion pounds from the Bank of England.


The consultation envisages that the Treasury will remain in charge of the overall framework of regulatory arrangements, the Bank of England of monetary policy and financial stability and the Financial Services Authority of supervision.

The Chancellor of the Exchequer or finance minister will remain ultimately responsible.

The Treasury is also consulting on how it can better protect deposits. Currently, only up to 35,000 pounds are guaranteed but the government may raise that limit and ensure compensation is paid to savers within a week of a bank being closed.

This could be achieved by allowing the Financial Services Compensation Scheme (FSCS) -- which oversees the system -- to immediately borrow from the Bank of England, or by forcing banks to pay into an insurance scheme in advance of a problem.

The current scheme is essentially financed after the event, unlike a deposit guarantee in the United States.

An element of “pre-funding” could be introduced “to allow the FSCS to build up a reserve fund over a period of years”, the consultation document said.

But the major banks are opposed to the suggestion, which analysts at UBS estimate could cost UK banks almost 3 billion pounds a year for several years.

“The worry for the industry is that we have a pre-paid deposit protection scheme ... it would cost an awful lot of money when banks are not flush with cash. In the end savers would pay in the form of lower interest rates,” one banking industry source said.


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