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Last Updated: Tuesday, 9 October 2007, 19:10 GMT 20:10 UK
Bank defends Northern Rock role
Mervyn King
Mr King said the run was like a fire started someone smoking in bed
Mervyn King, the governor of the Bank of England, has defended his decision not to lend money at cheap rates to avoid the run on Northern Rock.

"Nothing would have been easier than for the Bank of England to lend freely without a penalty rate," he told the Northern Ireland Chamber of Commerce.

He said that would have sowed the seeds of a greater crisis in the future.

Also on Tuesday, the Financial Services Authority (FSA) chief said there are "lessons to be learned" from the case.

The FSA's chief executive Hector Sants was giving evidence to the Treasury Select Committee, which is investigating the problems at the bank.

"In terms of the probability of this organisation getting into difficulty we had it as a low probability," Mr Sants told the committee.

"When events transpired, that proved to be incorrect," he added.

Poisonous

The chairman of the FSA, Sir Callum McCarthy, was also asked whether relations with the Bank of England had become "poisonous" as a result of the Northern Rock crisis.

Hector Sants
Mr Sants said there were problems with the stress-testing of the bank

A report in the Financial Times last month quoted unnamed FSA officials blaming the Bank of England for the crisis - the first run on a British bank in more than 100 years.

"I have good and clear relations with the governor," Sir Callum said

But he avoided questions about whether he urged the Bank of England to provide more funding to the banking market.

Central bank

In his speech in Belfast, Mr King said that some commentators had objected to his concerns about making sure institutions were not encouraged to take excessive risk.

He said that lending vast amounts of money at low rates of interest would have prevented the run on the bank - but that as soon as the crisis had ended, people would have started taking hefty risks again.

Mr King said some people had objected that fire departments put out fires even at the homes of people who smoke in bed.

But he replied that while they put out the fires, they do not offer free insurance to people who smoke in bed, which would encourage them to take risks that put others in danger.

Stress testing

The FSA is responsible for supervising financial institutions such as banks and it was asked why it was only doing a full review of Northern Rock's finances every three years.

Conservative MP Michael Fallon said: "You are dealing with a bank whose lending has quadrupled from 25bn to 100bn - it was taking one in five mortgages - and you were not doing a full assessment for three years."

Mr Sants replied: "I think there are lessons to be learned here with regard to our supervisory practice and I do think we need to look at our engagement with this company."

The last FSA full review of Northern Rock was in February 2006 although FSA officials had visited the company in July to question their "stress testing".

This is a process where banks and regulators examine what would happen to a bank's finances in a range of crisis scenarios.

Mr Sants agreed that there were problems with the stress testing which were not picked up earlier.

"We were uncomfortable with their scenarios but regrettably it was late in the day," he said.

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