Last updated: July 13, 2012 10:40 pm

Finance: The bank that roared

King has shown the Bank of England is back in charge of the City
lion figure©Bloomberg

Biting back: a metalwork panel adorns the Bank of England, which is baring its teeth after sidelining regulatory duties for more than a decade

The Parlours, the ornate Regency-style rooms running from the office of the governor of the Bank of England, have provided an eerily quiet backdrop for many of the country’s turbulent financial dramas.

But the meeting at 6pm on Monday July 2 was one of the more remarkable denouements to be acted out amid their heavy furnishings and wood panels. Sir Mervyn King, the BoE’s governor, called in Marcus Agius, chairman of Barclays Bank, and handed him the regulatory equivalent of a loaded revolver. It was made clear that Bob Diamond, then Barclays chief executive, was the intended victim.

The Bank of England is back in charge of financial stability. And it means business.

In the first decade after it gained independence in 1997, Britain’s central bank concentrated on controlling inflation and largely ignored its duty to “ensure financial stability”. Then the financial crisis struck in 2007 and the BoE progressively found it could neither ignore banks, nor leave their regulation to other authorities. But since the 2010 election Sir Mervyn, arguably Britain’s most powerful unelected official, has overseen a rapid transformation. His attitude to Barclays has demonstrated he is not just governor of the BoE, but seeks to be governor of the City of London.

Concerns about the bank’s record at exercising judgment over financial stability, however, are as numerous as plaudits for the new state of affairs, not least in the scandal surrounding the rigging of Libor interest rates that toppled Mr Diamond.

The first signs of the BoE’s new attitude came on June 29 at the launch of the twice-yearly financial stability report which, by chance, occurred two days after the revelation of Barclays’ involvement in seeking to manipulate Libor interest rates. Sir Mervyn attacked banking and bankers. “From excessive levels of compensation, to shoddy treatment of customers, to a deceitful manipulation of one of the most important interest rates, and now this morning to news of yet another mis-selling scandal, we can see that we need a real change in the culture of the industry,” he said.

And as for Mr Diamond – then still confident he would remain at the helm of Barclays – the governor refused opportunities to reassure the public that he was fit to run one of Britain’s most important banks. Banks needed “leadership of an unusually high order”, he said, adding that these leadership issues were “for another day and another place”. With the benefit of hindsight, it has become clear the revolver that would be handed via Mr Agius to Mr Diamond was already loaded.

Giving evidence to a parliamentary committee on Tuesday, Mr Agius recalled that fateful evening. “The governor was very careful to say that he had no power to direct us,” he said, but “we were told in no uncertain terms that he [Mr Diamond] did not have the support of the regulators”.

Tradition has it that in past times the BoE governor would raise an eyebrow when hearing about something dodgy in the City and banks would know immediately that activity had to stop. There were no such subtlety that Monday evening. It was a direct order. Mr Diamond had to go. And Mr Agius, as chairman, had to deliver the news even though he believed it was counter to the interests of Barclays.

The BoE’s more muscular approach to the financial sector was reinforced this week by Bob Jenkins, an external member of the Financial Policy Committee, the central bank’s new body designed to prevent excess lending in future. “How about a moratorium on all new regulation followed by a review and rollback of the rule book. In exchange, all banks everywhere would be required to raise their tangible equity capital to 20 per cent of assets,” he told a group of actuaries in a speech. That deal would force banks to hold about six times the level of capital proposed under the Basel III rules.

And on Friday, Sir Mervyn gave another clear sign he had ditched the BoE’s previous laisser-faire approach to bank funding and lending. He launched a £80bn scheme aimed at unsticking moribund bank lending. Having largely insisted since 2007 that high bank funding costs simply reflected the weakness of individual institutions, the governor now accepts that the difficulties might be caused by events beyond banks’ control.

The Treasury is delighted with the course of events. An aide to George Osborne, chancellor of the exchequer, said the governor’s action in regard to Barclays demonstrated exactly the new regulatory approach the chancellor had intended when he proposed giving the BoE sweeping new powers. It signifies “the return of judgments instead of box-ticking”, the aide said. “If only someone had curbed Fred the Shred’s ambitions in the same way. Only the BoE has the necessary authority to do that,” he said, referring to Fred Goodwin, former chief executive of RBS, who sparked uproar for keeping his £550,000-a-year pension despite presiding over the biggest banking collapse in history.

Along with praise for the BoE’s robustness came worries that the governor might have gone too far. Andrew Tyrie, chairman of the Treasury committee, said of Mr Diamond’s sacking: “I don’t think that looked good”.

It is also untrue to say the British authorities had previously failed to exercise judgment when it came to frustrating banks’ ambitions. As Lehman Brothers teetered on the brink in September 2008, the Financial Services Authority, the existing banking supervisor due to be partially subsumed into the BoE, and Alistair Darling, chancellor at the time, saved Mr Diamond from himself, and UK taxpayers by blocking Barclays’ attempts to buy Lehman. “We could not stand behind any deal until we knew precisely what were the risks,” Mr Darling wrote in his memoirs. “In any event, we [UK taxpayers] could not stand behind a US bank that was clearly in trouble.”

The BoE’s record on exercising judgment over financial institutions is also far from spotless. Sir Mervyn admitted in May that the bank had been too standoffish in the past on the matter of financial stability. “With the benefit of hindsight, we should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so-called ‘light-touch’ regulation hadn’t prevented any of this,” he said.

The central bank has often appeared indifferent to regulatory matters. On Monday, giving a coherent and robust defence of the BoE’s actions in October 2008, Paul Tucker, deputy BoE governor and candidate to become the next governor, was able to demonstrate convincingly that he had not tacitly encouraged Barclays to fiddle its Libor quotes at the height of the financial crisis. But he came unstuck on why the BoE had turned a blind eye to irregularities in the Libor market it had minuted as early as November 2007.

Sir Mervyn now remembers that in 2008, BoE officials “were encouraging people to move towards the use of actual transactions data [in setting Libor], there was very little support at that stage among the markets, among banks, and indeed among our overseas colleagues, to make the change to the system”. That version of events given on June 29 does not tally with the concerns the Federal Reserve Bank of New York sent to the BoE, which the bank merely forwarded to the British Bankers’ Association and did not feel the need to submit a response to its consultation on Libor procedures.

The evidence of the past week also shows the BoE has not taken on board the widespread criticism it has faced from parliament over its internal management hierarchy, transparency and poor communications skills.

Faced with a threat from Barclays to implicate the BoE and Mr Tucker in the Libor scandal, senior management went to ground and the bank was unable to provide its convincing defence for six days. The long delay ensured that Mr Tucker – not a well-known figure in public – appeared in pictures next to Mr Diamond in nearly every newspaper and on television. While not fatal, this has stripped Mr Tucker of his status as favourite to become governor next year.

Meanwhile, the stock of Adair Turner, chairman of the FSA and also a hot contender to become governor, has been enhanced considerably by the publication of a damning letter he wrote to the chairman of Barclays in April. Giving a long list of Barclays’ weaknesses, he wrote: “The cumulative effect of the examples set out above has been to leave us with an impression that Barclays has a tendency continually to seek advantage from complex structures or favourable regulatory interpretations.”

This week has shown the BoE is back in charge of the City. But it has also shown the central bank’s oddities, weaknesses, and pre-crisis failures. The structural changes, giving the BoE more power than the central bank of any other advanced economy, are almost a done deal, most likely to be implemented next spring. But as ministers limber up to decide Sir Mervyn’s successor this autumn, the BoE might find its myriad weaknesses prevent an internal candidate getting the nod.

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