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The influential Parliamentary committee said that last September’s queues at Northern Rock constituted the first run on the retail deposits of a United Kingdom bank since Victorian times.

The committee’s report analyses the causes and consequences of the run on Northern Rock, and the lessons to be learnt from it.

It emphasises the advantages of legislative change on a cross-party basis and make proposals for such change, and for reforms of the Tripartite (HM Treasury, Bank of England and the FSA) arrangements, on that basis.

Reckless business model

Committee chairman John McFall says that the directors of Northern Rock were the principal authors of the difficulties that the company has faced since August 2007.

“The directors pursued a reckless business model which was excessively reliant on wholesale funding,” McFall adds.

Mervyn King, the governor of the Bank of England, told the committee, “It was the business strategy that was fatally flawed in this episode where, once those markets had closed in mortgage backed securities, they were absolutely unable to finance their wholly illiquid assets.”

The Treasury Committee says that it is right that members of the board of Northern Rock have been replaced, though haphazardly, since the company became dependent on liquidity support from the Bank of England.

“The high-risk, reckless business strategy of Northern Rock, with its reliance on short- and medium-term wholesale funding and an absence of sufficient insurance and a failure to arrange standby facility or cover that risk, meant that it was unable to cope with the liquidity pressures placed upon it by the freezing of international capital markets in August 2007,” according to the report.

Systematic failure

Given that the formulation of that strategy was a fundamental role of the Board of Northern Rock, overseen by some directors who had been there since its demutualisation, it attributes the failure of that strategy also to the board.

“The non-executive members of the board, and in particular the chairman of the board, the chairman of the risk committee and the senior non-executive director, failed in the case of Northern Rock to ensure that it remained liquid as well as solvent, to provide against the risks that it was taking and to act as an effective restraining force on the strategy of the executive members,” the committee adds.

The report goes on to say that the Financial Services Authority “systematically failed” in its regulatory duty to ensure that Northern Rock would not pose a systemic risk.

It did not allocate sufficient resources or time to monitoring the bank, in the eyes of the committee, and its procedures were inadequate to supervise a bank whose business grew so rapidly.

The MPs say that if the Financial Services Authority was "very unhappy" with the stress testing conducted by Northern Rock, it appears to have failed to convey the strength of its concerns to the Board of Northern Rock, and to secure remedial action.

Although the Board of Northern Rock undertook some stress testing of its own business model, it proved to have been thoroughly inadequate in their opinion. They point out that it was the responsibility of the Financial Services Authority to ensure that the work of the Board of Northern Rock was sufficient to the task.

Lack of relevant financial qualifications 

The committee expresses concern that the chief executive of Northern Rock, Adam Applegarth was not a qualified banker, although he had significant experience.

“The Financial Services Authority should not have allowed nor ever again allow the two appointments of a chairman and a chief executive to a "high-impact" financial institution where both candidates lack relevant financial qualifications,” the committee says.

It adds that an appropriate professional qualification is one indication that an individual has been exposed to the relevant training and that absence of such a qualification should be a cause of concern.

The committee therefore recommends that the FSA undertake an urgent review of the current qualifications of senior directors in financial firms, especially of those firms considered to be "high-impact", and ensure that the current approved person regime requirements are adequate.

Shareholders

The committee points out that the business model of the board of Northern Rock was clearly stated. It concludes that it is unfortunate that the shareholders who acquired their shares as part of demutualisation and the staff of Northern Rock have suffered significantly from the fall in the value of Northern Rock shares.

“It is not possible, however, to make a distinction between types of shareholders in the circumstances of Northern Rock. In a market environment, shareholders as a whole must be viewed as taking a risk from which they sought a reward and for which they are now paying a price,” the committee adds.

The select committee says that bank shareholders appear to be protected from the total collapse of their firm by the state's unwillingness to allow a bank to fail at the moment. Its proposals would remove this taxpayer-funded prop, equalising the status of bank shareholders with that of non-financial firms' shareholders, who receive no such assistance. 

The MPs are keen to stress that the taxpayer should not bear the risk of banks failing. Nor do they believe that small depositors should bear such risk. Rather, they believe the risk of failure should be borne by a bank's shareholders and creditors but exclude small depositors.

"The Government must ensure that the framework for handling failing banks insulates taxpayers and that small depositors should also be protected from the risk of banks failing," according to the committee.