Page last updated at 12:00 GMT, Tuesday, 1 July 2008 13:00 UK

Bank triumphs in finance shake-up

By Steve Schifferes
Economics reporter, BBC News

Bank of England
A beefed up Bank of England will oversee financial stability

The Bank of England has emerged triumphant in the shake-up of financial regulation following the Northern Rock debacle.

New proposals published on Tuesday have given the Bank the ultimate power to run a failing bank under a "special resolution regime", which would trigger a Treasury pay-out of billions of pounds to depositors.

The FSA would trigger putting a bank into such a regime, based on its assessment of the viability of the bank, in consultation with the Treasury and the Bank of England.

The Treasury says it will ultimately be able to recover the money from the failing bank, and charge an increased levy on all other banks in the financial sector.

But it has been forced to retreat from its plans to "pre-fund" the scheme by requiring banks to put more cash up front in advance of any problems occurring.

The Treasury says the time is not right to demand more payments from the banks because the banking system is still stressed from problems in the world's financial markets. But it plans to give itself to powers to make such a levy in the future.

At the same time, the commercial banks are fighting a fierce rearguard action to avoid being landed with the huge costs of future pay-outs were another UK bank to go bust.

Limits to coverage

The result is that the new deposit protection scheme - with its "suggested" upper limit of 50,000 - will at best only cover two-thirds of total UK bank deposits (although 97% of depositors).

And the Financial Services Agency (FSA) will still need to consult further with the banks about the upper limit figure, which is far less than the 100,000 that the Chancellor first suggested when the crisis broke, although it is broadly in line with international practice.

Other issues also exists, such as individuals who have deposits with two different financial brands owned by the same bank only being covered once, for 50,000.

Person taking 20 pound note out of wallet
Consumers are not willing to take chances over the safety of their cash

The Bank of England has also triumphed in getting the government to introduce a secrecy clause which will allow it to offer emergency support to failing banks without making the information public.

Bank Governor Mervyn King has already made it clear that, in his view, it was the lack of such powers that caused the run on the Northern Rock bank.

Mr King will also be given further powers, as he will be able to demand, via the FSA, any information necessary to maintain financial stability, and it is also proposed that individuals who disclose problems at a bank will be given immunity from prosecution.

Furthermore the Bank of England will be given an explicit remit - in the form of a letter from the chancellor - that one of its central roles is to preserve financial stability, of equal weight to its objective of keeping inflation in check.

The governor gets a new financial stability committee to help with his task, and he has eased out the key bank official responsible for financial stability during the Northern Rock crisis - Sir John Gieve, who was the subject of fierce criticism by the Treasury Select Committee last year.

Remarkable turnaround

All in all, it is a remarkable turnaround for the Bank of England, which was widely blamed for failing to act quickly enough during the Northern Rock crisis.

Now the Bank will have a central and enhanced role in maintaining financial stability, the power to manage a bank that has failed, and the right to call on unlimited Treasury assistance to fund the rescue.

It is a severe rebuke for the FSA, which was judged to have performed poorly in supervising Northern Rock both by the Treasury Select Committee and by its own internal audit.

But in relative terms it is an even bigger reduction of powers by a weakened Treasury, which is essentially ceding control of financial stability to the Bank.

It moves the UK much closer to the US model where the Federal Reserve has the ability to act independently of the government - although ultimately, as with the Bear Stearns rescue, it is also the Treasury that pays the bill.

Banks reject saver deposit plan
05 Mar 08 |  Business
Secret bank rescues to be allowed
30 Jan 08 |  Business
Card fraud at Northern Rock in US
09 Jun 08 |  Business
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30 May 08 |  Business
FSA 'failed over Northern Rock'
26 Jan 08 |  Business

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