The timing is not good for Mervyn King. Having received praise for his stewardship of monetary policy for most of his first term as Governor of the Bank of England, he has found himself in the middle of a banking crisis with the clock ticking on his reappointment by the Prime Minister.
Alistair Darling's pledge on Monday that the Bank of England would guarantee the savings of every Northern Rock depositor was unprecedented. But so were the scenes that had led up to the Chancellor's intervention, as thousands queued outside the FTSE 100 bank to get their money out.
Mr King and the Bank of England are in the firing line of what has become a political storm. Tomorrow he faces a grilling by the House of Commons' Treasury Committee and his performance will be keenly watched.
Michael Fallon, the senior Conservative on the Treasury Committee, said Mr King is set to face "hard questions" about the Bank's role in the Northern Rock crisis. "He has some explaining to do on Thursday morning about the sequence of events and how the Bank has changed its stance over them."
Mr King's term as Governor finishes at the end of June, and Gordon Brown and the Chancellor can announce their decision at any time before then. Those who are working in financial markets have homed in on the political nature of Mr King's reappointment.
"Turmoil in financial markets, tighter credit-lending and a housing market slow-down on the back of five interest hikes will cast new light on King's record," said Mansoor Mohi-uddin, global head of foreign exchange strategy at UBS. "The decision to re-appoint King will be taken by Prime Minister Brown with one eye on the early general election that he may call next year."
Mr Mohi-uddin said that any uncertainty over Mr King's future would weigh on the value of the pound, and that a change of Governor would be a shock to the currency.
Some banks have been irritated by the tone of the Governor's response. In a letter to the Treasury Committee last week, Mr King played the role of the hard taskmaster, telling financial institutions they should have known better and would have to take their punishment.
"It's almost a Dickensian approach to it," said Nigel Terrington, chief executive of Paragon, the buy-to-let mortgage lender whose shares were hit by Northern Rock fears. "These are circumstances the like of which we haven't seen before and people are going to be berated left, right and centre. Some may be justified and some will be unfair."
Mr King has taken the hardest line of major central bankers on the credit crunch. As the European Central Bank released funds to boost liquidity and the Federal Reserve moved towards yesterday's interest-rate cut, Mr King ruled out reducing rates or injecting emergency funds to free clogged markets as banks refused to lend to each other.
Critics are concerned that the Bank did not see the crisis coming. The Governor said on 8 August that the problems in the markets caused by the panic over US sub-prime lending were "not an international financial crisis". But the seizing up of the credit markets the next day was to lead to Northern Rock's downfall as its sources of funding were cut off. But the unprecedented panic in financial markets caught most people off guard.
A further criticism is that the Bank has been too rigid in its response to the crisis, invoking rules and making stern warnings when what was needed was an injection of confidence and money to get the markets moving again.
Banks are understandably reluctant to criticise the Bank of England, but Bob Diamond, the president of Barclays, went public last month with some thinly veiled barbs about the Bank's reluctance to inject cash into the system. Mr King has said that it is up to institutions to work through their problems and there is no evidence that injections of cash from the Bank would solve the problem.
"Perhaps the Bank of England is underplaying its ability to influence rates as far out as three months," said Philip Shaw, chief economist at Investec. "I suspect they could influence those rates."
Mr King's main concern in taking a tougher stance than the Fed or the ECB has been to avoid "moral hazard" – giving people incentives to do the wrong thing. He set out his position in his letter to the Treasury Committee when he said: "The provision of large liquidity facilities penalises those financial institutions that sat out the dance, encourages herd behaviour and increases the intensity of future crises."
Critics also say the Bank has had to backtrack on its hardline stance. On Thursday Northern Rock announced it had been given an unlimited loan facility by the Bank at a penal rate to get it through its liquidity crisis. The backing of the central bank was meant to reassure the public but instead savers queued from dawn to get their money out of the stricken bank, leading to Mr Darling's announcement on Monday.
The Bank had already made limited moves to make money available to the markets and softened the requirements for banks to keep to their reserve targets. Yesterday the Bank made £4.4bn available for banks to borrow against Government bonds two days earlier than the date on which it would normally have done so under the limited arrangements it brought in to meet the crisis.
Mr King's supporters say that – short of the Government's public guarantee – all these measures were in the Governor's armoury to be deployed if required.
A banking industry source said that, having made the funds available to Northern Rock, Mr King's response to the crisis was disappointing, and that he should have reassured scared depositors that their money was in fact safe.
"It has not been great," the source said. "When you invoke the lender of last resort scheme you have to be very active on TV and radio. The authorities were invisible on Friday and the banking industry has paid the price."
A major problem for Mr King and the FSA was that Northern Rock is a publicly traded company, restricting the comments the regulators could make about it. Disclosure rules are now so tight that it was difficult to comment, and it was not in Mr King's gift to offer the unlimited backing that the Government eventually guaranteed.
Some banking sources say the problem is not with Mr King but with the regime that was introduced when the Bank got its independence in 1997. Banking industry sources have expressed increasing disquiet about the results of splitting banking regulation between the Bank and the FSA, and MPs will ask Mr King about this.
The split took away the powers that had made previous governors so feared by the banking world. If Mr King wanted to be more actively involved with the financial system like his predecessors, he certainly got what he wished for.Reuse content