U.K. Approach to Financial Crisis Management

• Author: Dalvinder Singh
• Position: Associate Professor of Law, University of Warwick, United Kingdom
• Pages: 868-922

U.K. Approach to Financial Crisis Management

Dalvinder Singh*

I. INTRODUCTION ............................................................................ 869

II. THE CAUSES AND CONSEQUENCES OF THE FINANCIAL CRISIS ... 870

A. The U.K. Casualties......................................................... 876

B. The Icelandic Banks and the U.K. Experience ............... 879

III. THE MACRO- AND MICRO-PRUDENTIAL SYSTEM OF OVERSIGHT

TO CONTAIN A FINANCIAL CRISIS ............................................... 882

IV. THE U.K. TRIPARTITE AUTHORITIES AND THE MEMORANDUM

OF UNDERSTANDING: STRUCTURING DECISION-MAKING ........... 886

V. LENDER OF LAST RESORT ........................................................... 891

A. Northern Rock and Lender of Last Resort? .................... 895

VI. BEYOND LENDER OF LAST RESORT ............................................. 900

A. Blanket Guarantees ......................................................... 902

B. The Rescue Package of October 2008 .............................. 907

C. The Special Liquidity Scheme ........................................ 910

D. The U.K. Government’s Asset Protection Scheme .......... 912

E. United Kingdom Financial Investments Ltd ................. 914

F. Financial Crisis Management: Some Reflections on the

Responses thus Far .......................................................... 917

VII. CONCLUSION ............................................................................... 921

ABSTRACT

National govern ments hav e been forced to use an extraordinary amount

of public resources and techniques to contain the global financial crisis (―the

* Dr. Dalvinder Singh, Associate Professor of Law, University of Warwick, United Kingdom. I

would like to thank John Raymond LaBrosse, Honorary Visiting Fellow, University of Warwick

and former General Secretary of International Association of Deposit Insurers, Gillian Garcia,

formerly at the IMF, Sebastian Schich, OECD and David Mayes, University of Auckland, for

their very helpful comments. I would also like to thank Miles Binney for his research assistance

and the editorial board members of Transnational Law and Contemporary Problems for their

assistance and patience. All errors remain my responsibility. This Article was presented at the

University of Iowa College of Law symposium entitled Global Meltdown: Examining the Worst

Global F inancial and Economic Crisis Since the Great Depression on February 2009 and was

updated in May 2009.

Winter 2011] U.K. APPROACH TO FINANCIAL CRISIS MANAGEMENT 869

crisis‖). This Article analyzes the role of the U. K. Tripartite Authorities in

dealing with the crisis—both the ―ord inary‖ measures it used, such as the

Bank of England‘s role as Lender of Last Resort, and the ―extraordinary‖

measures it used, such as blanket guarantees, recapitalization, and asset

purchase schemes. It evaluates the U.K. response and the challenges of this

period of containment by comparing issues that arose from past financial

crises. This Article concludes that the containment of a financial crisis of

systemic proportions requires both an overarching and a case- by-case

approach to de al with banks experiencing insolvency rather than liquidity

problems.

I. INTRODUCTION

Containing the recent financial crisis that has beset global financial

markets has required a comple x, multifaceted response. The crisis aro se

when banks, the principal vehicle for providing credit in the economy , ceased

to function and provide credit on the kind of scale to which the economy had

become accustomed. When the ban ks and the financial system lo st confidence

in one another, governments intervened. In light of the international

financial crisis, this Article analyzes how the U.K. Tripartite Authorities

(―U.K. Authorities‖), namely H.M. Treasury, Bank of England (―the Bank‖),

and the Financial Services Authority ( ―FSA‖), worked together to contain the

financial crisis in the United Kingdom. This Art icle primarily analyze s, in

light of international expe rience, some of the techniques the U.K. Authorities

used to contain the financial crisis.

Part II of the Article explores the causes and consequences of the

financial crisis, both in the United States and more thoroughly in the United

Kingdom. It primarily explores the crisis in two broad pe riods—2007 and late

2008—namely, before and after the collapse of Lehman Brothers (―Lehman‖).

It provide s context for the Article by highlighting that what occurred in the

international financial markets, after the collapse of Lehman, were

unforeseen events, which required unprecedented government intervention.

While the crisis in confidence in the financial markets reached a turning

point in mid-2007, the economists working in the markets expected this to be

short lived and containable. But the collapse of confidence into a panic in

later 2008 was not foreseeable, and it resulted in the near meltdown of the

financial systems, which required individual and concerted government

intervention. In the United Kingdom, Northern Rock PLC, a very early

casualty of the financial crisis was, by late 2008, simply one of a group of

banks that needed government intervention. Part III of this Article explores

what the financial crisis ide ntified from a regulatory perspective . It primarily

identifies a lack of a coherent link between what is referred to as ―macro-‖

and ―micro-prudential‖ oversight of the financial system. The complexity of

the causes of the financial crisis demonstrates the number of weaknesses in

this area and derails support for a holistic oversight of the financial system.

The U.K. Authorities quickly put in place new measures to deal with problem

banks and they increased the coverage limit o f the country‘s deposit

870 TRANSNATIONAL LAW & CONTEMPORARY PROBLEMS [Vol. 19:868

insurance system, two key elements of better macro - and micro-prud ential

oversight. However, these measures did not sufficiently deal with the panic of

October 2008.

Part IV of this Article sets out the responsibilities of the U.K. Authorities.

It analyzes how they worked together and how, despite identifying risks in

the financial system prior to the financial cri sis, the y produced little change

to resolve systemic problems. This part suggests that the causes of the

financial cr isis were foreseeable, even the liquidity risk in securitizing

subprime mortgages in the United States. Part V analyzes the role of Lender

of Last Resort (―LOLR‖) from a U.K. perspective in light of the Northern Rock

litigation. It analyzes the rationale of LOLR and the reluctance on the part of

the Bank to provide this type of loan to failing banks. It highlights that under

the theory behind LOLR, a central bank sees this solution as the first step to

intervene with a bank in distress. This Ar ticle argues that due to the size and

complexity of the financial crisis , the Bank and the LOLR a lone were not

sufficient to contain the financial crisis once it took hold in late 2008. Part VI

of the Article analyzes the other measures to which the U.K. Authorities

resorted and which took them into unchartered territory, widening the use of

collateral the Bank would accept fo r liquidity, blanket guarantees,

recapitalization, and the introduction of the asset protection scheme. It

suggests that the role of H.M. Treasury is inevitable and necessary , but the

decision surrounding the rescue of banks and the tools to be used should be

conferred to a separate committee such as a Financial Stability Committee,

which U.K. Authorities would propose. Under this proposed scheme, the

Financial Stability Committee‘s responsibilities would extend beyond what

others have proposed. This part of the Article evaluates the use of these

measures in light of international experience and how the U.K. Authorities

implemented them. It highlights the conditions linked to the assistance, such

as extending lending to the econo my and limiting bonuses, to appease the

public concern about the use of taxpayers‘ funds to support failing banks .

This Article finally concludes by reflecting on the financial crisis and the U.K.

efforts to contain it.

II. THE CAUSES AND CONSEQUENCES OF THE FINANCIAL CRISIS

Future generations w ill remember the summer of 2007 as the star t of

what is probably the worst financial crisis since 1933.

1

The crisis, sparked by

the increasing level of defaults in the U .S. subprime mortgage market, was

caused by a number of interconnected elements.

2

This section will explore

1

Adair Turner, Fin. Serv. Auth. Chairman, Beyond the Current Turmoil: The Future Shape of

Global Finance, Address at the International Banking Seminar (Oct. 13, 2008), available at

http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2008/1013_at.shtml.

2

HOUSE OF COMMONS TREASURY COMMITTEE, FINANCIAL STABILITY AND TRANSPARENCY: SIXTH

REPORT OF SESSION 2007–08, H.C. 371, at 24–26, available at

http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/371/371.pdf; INT‘L