Carte blanche for banking authorities?

By Ian Pollock
Personal finance reporter, BBC News

The government's decision to guarantee 100% of all Northern Rock deposits appears to have eased the pressure on the troubled bank, at least for now - but the details remain far from clear.

The Bank of England is a cornerstone of the plan

The Chancellor, Alistair Darling, said on Monday evening: "Should it be necessary, we, with the Bank of England, would put in place arrangements that would guarantee all the existing deposits in Northern Rock during the current instability."

Just to make sure we got the message, he added: "This means that people can continue to take their money out of Northern Rock, but if they choose to leave their money in Northern Rock it will be guaranteed safe and secure."

How will that work, though? And exactly what powers do the government and Bank of England have to make such a promise?

Reserve powers

It looks as if the government plans to use a reserve power, granted to it under the 1998 Bank of England Act.

I'm sure the Act will allow them to do it Professor Geoffrey Wood

One of the reserve powers is that: "The Treasury, after consultation with the Governor of the Bank, may by order give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances."

This is the Act which, among other things, codified in law Gordon Brown's first decisions as Chancellor in 1997.

He established the Bank's monetary policy committee, gave the Bank independence in setting interest rates, and also took supervision of individual banks away from the Bank of England and gave that power to the Financial Services Authority (FSA).

"In a situation like this, recourse is to the taxpayer," said banking expert Professor Geoffrey Wood of the Cass Business School in London.

"The Act entrusted responsibility for the stability of the financial system to the Bank, the FSA and the Treasury jointly.

"And if these three agree that the way to maintain financial stability is to do this, then I'm sure the Act will allow them to do it," said the Professor.

Practicalities

How a complete bailout of Northern Rock savers would work in practice, if push came to shove, has not been established.

I never thought I'd live to see the day when we saw a run on the banks Ken Clarke, former Tory chancellor

When I spoke to the Bank of England this morning, a spokesman said: "I have to steer you to the Treasury."

The Treasury, however, is still formulating an answer.

Mr Darling, for his part, told the BBC: "It [the depositors' guarantee] will be in place for as long as these difficulties are maintained.

"If it were to prove necessary, the same facility would be there [for other banks]."

In fact, the FSA's chairman Sir Callum McCarthy said it was "improbable" that the government would have to pay any money on its new promise.

Discussions

The range and scale of the existing Financial Services Compensation Scheme (FSCS) are now being examined by the authorities, to see if its current levels of compensation are adequate to maintain public confidence.

But an FSCS spokeswoman stressed that the government's new guarantee was "something we cannot comment on".

"Northern Rock is still solvent, so it is nothing to do with us yet," she said.

So, all this means the authorities are still pondering the practicalities of any contingency plan, as it is something they have never had to do before.

"There are probably discussions going on," said a source.

In reality, the authorities are hoping that they will never actually have to come good on their promise to the Northern Rock's 1.5 million savers, and that warm words will be enough to dispel the panic among the bank's customers.

The Northern Rock believes this is starting to happen, pointing to a sharp downturn in calls and queues of customers.

What about the government guarantee though?

"It's all a totally hypothetical question at this stage," said a Northern Rock spokesman.

The former Conservative Chancellor Ken Clarke, however, described the promise of a bailout for savers as a "blockbuster" of a policy.

"I never thought I'd live to see the day when we saw a run on the banks," he said.