U.K. Approach to Financial Crisis Management

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

National governments have been forced to use an extraordinary amount of public resources and techniques to contain the global financial crisis (?the crisis?). This Article analyzes the role of the U.K. Tripartite Authorities in dealing with the crisis-both the ?ordinary? measures it used, such as the Bank of England‘s role as Lender of Last Resort, and the ?extraordinary? measures it used, such... (see full summary)

 
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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 riods2007 and late
2008namely, 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 200708, H.C. 371, at 2426, available at
http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/371/371.pdf; INTL

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