The Government is expected to bring in swift legislation to reform the system of financial regulation in an attempt to prevent a repeat of the Northern Rock crisis.
An urgent shake-up of the current arrangements looks inevitable after Mervyn King, the Governor of the Bank of England, told MPs yesterday that the rules as they stand prevented the Bank from intervening to nip in the bud the problems which engulfed Northern Rock.
Mr King survived a bruising two-and-a-half-hour grilling by the Commons Treasury Select Committee and appeared to have seen off any immediate threat to his position as Downing Street expressed "full confidence" in him. But there are doubts over whether he will see a second spell as governor when his five-year term ends next June.
The Governor faced embarrassing criticism from MPs, who found fault with the Bank for not raising the alarm about gaps in the regulation system and not stepping in more quickly to rescue Northern Rock. Sir John Gieve, his deputy, had an even more difficult time after admitting he took a two-week holiday even though he knew problems were looming at the bank. John McFall, the committee's Labour chairman, accused him of being "asleep in the back shop" and compared the Bank's performance to "shouting 'fire' in a crowded cinema".
The prospects of early reform of the regulations were boosted when George Osborne, the shadow Chancellor, offered the Government the Tories' full co-operation to rush through legislation as soon as Parliament returns from its summer recess next month.
He said a law making it easier for the Bank of England to preserve the stability of the financial system was an urgent priority. Mr Osborne added the reforms should include a new deposit insurance scheme to protect 100 per cent of people's savings up to a much higher level than the £2,000 currently covered. One option would be to raise it to the £50,000 level offered in the United States.
Mr King revealed he had tried to mount a "covert" attempt to head off the problems at Northern Rock without its customers knowing it was in danger but discovered that a European Union directive on market abuse introduced in 2005 stood in the way of the Bank intervening as it had done previously.
The Governor called for speedy "serious reform" of the regulations, including the insurance for depositors in the event of a bank failure. He said: "The interaction between different pieces of legislation made it almost impossible to act as a lender of last resort." He had wanted to conduct a "covert" support operation which would not have led to a run on Northern Rock, but "strong legal advice" had been that such a course of action was not possible.
Mr King said the Chancellor, Alistair Darling, would have been warned as early as 14 August that Northern Rock was exposed by the global credit crunch but insisted it would have been "irresponsible" to have acted any earlier.
He denied coming under political pressure to rescue Northern Rock. "I give you my personal assurance I would never do anything unless I thought it was the right thing to do," he told the MPs.
Mr McFall accused the Bank's bosses of "obfuscation" and told Sir John: "Frankly, I do not think you are doing your job." He said the Deputy Governor, who is also a board member of the Financial Services Authority, appeared laid back about the problems. "People were talking about Northern Rock, they were talking to me about Northern Rock, others were talking about Northern Rock so I think it's absurd that you should come here and say you didn't know anything about it – you are the guy in charge of financial stability," he said.
Sir John insisted he had been "alert to the dangers" in the financial markets but that it was not his position to be scrutinising individual banks. "If you say, did we see exactly how it would pan out and why it would impact on Northern Rock, which had no particular sub-prime connections, no we didn't see that," he said.
Bank under fire
"Frankly, I do not think you are doing your job... [you were] asleep in the back shop."
John McFall, Labour chairman of the Treasury Select committee, to Sir John Gieve, the Bank's Deputy Governor
"It's a bit like the fireman turning up at your door and saying the fire engine doesn't work."
Michael Fallon, Tory member of Treasury, on the Bank's refusal to flag up that the system did not allow it to intervene
"The equivalent of screaming 'fire' in a crowded cinema. There is absolute panic, all as a result of one company maybe having a bad business model."
John McFall on the action taken to help Northern Rock
"They took a rationalinterpretation of what the endgame might be."
Mervyn King, Governor of the Bank of England, on the Northern Rock savers who queued up to draw their money out