Thursday, November 01, 2007

Will We Ever See the London Approach Again?

In days gone by the Bank of England knew how to step in and help ailing banks. The London Approach came to the fore in the 1970s when the secondary bank market faced collapse. The Bank was able to work with other banks to organize rescues and bailouts. No direct interference occurred but suasion and negotiation were mobilized to forge action.

Northern Rock has shown how the system can no longer respond quickly or effectively. The tri-partite system of regulation shared between the Bank of England, the Financial Services Authority and the Treasury has eviscerated the capability of the Bank to move quickly and quietly. Indeed, Mervyn King, the Bank's governor, remarked to the Treasury Select Committee that his hands were tied by inconvenient pieces of legislation.

Instead, we now see the London Approach being applied by other countries. The Federal Reserve showed how it could be used when Long Term Capital Management imploded in 1998. And it has encouraged the banks to support the Superfund to buy distressed debt. Germany was able to galvanize its banks and central bank to assist IKB and Sachsen LB when they were threatened by their exposure to the US subprime mortgage debacle. Even the European Central Bank could offer liquidity to its markets without struggle.

While the US and Germany have offered succour to their ailing banks, the UK is bereft of any means to ameliorate a worsening financial situation. Now the Bank of England is reconsidering its position and may relax its rules on collateral, which sounds like it wants to return to the old days of the London Approach. But as its chief economist, Charlie Bean, said, there are too many known unknowns and unknown unknowns around at the moment for that to occur. Moreover, it would require the Treasury to reconfigure the rules around bank supervision. If the FSA can't really do it, perhaps the Bank should.

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