U-turn raises heat on UK Bank governor

The Financial Times ^ | 9/19/2007 | Chris Giles and Peter Thal Larsen

[bruinbirdman]

Mervyn King will be forced to mount a public defence of his reputation as Bank of England governor after being driven into a striking policy U-turn on Wednesday in a bid to ease pressure on the UK banking system.

The Bank’s change of heart came after a series of high-level meetings on Tuesday involving the Financial Services Authority, the Treasury and some of the City’s largest institutions, where concerns were aired that the crisis at Northern Rock could spread to other smaller lenders, such as Alliance & Leicester and Bradford & Bingley.

Mr King will face an interrogation by MPs on Thursday over his stewardship of the financial system and his role in the recent run on the Northern Rock bank.

In an attempt to inject more liquidity into the system, the Bank has offered to lend tens of billions of pounds on three-month terms to cash-strapped banks that provide mortgages, starting with an initial injection of £10bn (€14.3bn) next week.

The move by the Bank, which had stood out among global central banks for taking a “tough love” line, came less than a week after Mr King warned that such actions could sow “the seeds of a future financial crisis”.

According to people who attended Tuesday’s meetings, Hector Sants, the FSA’s chief executive, urged the banks to lend to each other in the inter-bank market to prevent other smaller banks having to face a similar fate to Northern Rock. Regulatory officials were keen to stress that no other banks were facing imminent problems.

But Mr King stands accused of helping Northern Rock founder by acting tough with UK banks, only to step in later with emergency funding and finally agreeing to the action that bankers believe would have been enough to have headed off the debacle before it hit the high street.

Senior banking executives believe the recent crisis has also shown the frailty of financial regulation, where responsibility is split between the Bank, the FSA and the Treasury.

The Bank is expecting heavy criticism at Thursday’s hearing of the House of Commons Treasury select committee. But it insists the latest move was necessary because the situation had changed and action was needed “to alleviate the strains in longer-maturity money markets”.

The move is a significant change in direction for the Bank. Senior officials have been sceptical over the past month about whether similar action from the European Central Bank and the US Federal Reserve was effective. Until now, the Bank had only lent money at penalty rates overnight and only for high-quality collateral such as gilts.

The Bank and the Treasury insist the decision to change policy was not made under instructions from the Treasury.

Although the new policy is bound to raise questions about whether Mr King’s term will be renewed next year, the Treasury said on Wednesday night: “The governor has our absolute support.”