Given the Bank of England's failure to meet its target of controlling inflation, it may seem odd that the UK's central bank is about to assume new responsibilities. When the Northern Rock debacle erupted last autumn, there was talk of Mervyn King losing the leadership of the Bank, but in the ensuing power struggle between the Government and the Governor, King has emerged the winner.
In the next few days, as part of a new Banking Act, Chancellor Alistair Darling will reveal details of plans to return the role of rescuing beleaguered banks to the Bank of England – 11 years after Labour, under its newly appointed Chancellor, Gordon Brown, stripped Threadneedle Street of those responsibilities.
King was deputy to the Governor, Eddie George, when Brown ordered that the nascent Financial Services Authority, the City regulator, would in future monitor banks. It was George's punishment for not preventing the collapses of BCCI and Johnson Matthey. Yet following the FSA's own failure to identify Northern Rock's vulnerability, the Bank is again being given a key role in supervising the sector.
That is despite King's resistance to a rescue of Northern Rock being blamed for turning a drama into a crisis, and despite his having to write to the Chancellor explaining the Bank's failure to control inflation. But Darling is not only giving King new powers; he last month lost a battle with him over who would become the Governor's new deputy.
Charles Bean, the Bank's chief economist, was promoted to deputy governor with responsibility for monetary policy even though Darling had argued that, with a credit crunch biting, the job should go to someone with banking experience rather than an academic economist.
For King, this victory settled a score with the Treasury following the appointment two and a half years ago of Sir John Gieve as deputy governor responsible for financial stability. Sir John was a career civil servant and permanent under-secretary at the Home Office when he was moved to the Bank, and King made it clear he wanted someone who could work with the private sector.
Prior to Sir John's appointment, King had written to Brown setting out two requirements for his new deputy. "First, to lead the Bank's work on financial stability ... working with others outside the Bank – both at the FSA and the Treasury but also in the private sector.
"Second, the deputy governor for financial stability has an important international role to play. He or she would have to work closely with the Financial Stability Forum, the Federal Reserve, the European Central Bank and other public or private sector groups. Someone with experience of, or an aptitude for, that international dimension would be well suited to the task".
King reminded Brown of the regulatory role that had been taken away from it in 1997 and said: "The Bank is now a smaller and much more focused organisation. It is important we find someone who will be able to play the roles of deputy governor, member of the Monetary Policy Committee and member of a small senior management team able to work with the existing members of the Bank."
With his domestic background in Whitehall, Sir John didn't match King's job description, and the Governor accompanied his letter to the Chancellor with a list of names, including some from the private sector, whom he did consider suitable.
Sir John, nevertheless, was appointed deputy and in that capacity was also given a seat on the board of the FSA. Yet when grilled by MPs on the Treasury Select Committee, he admitted he had not even read Northern Rock's report and accounts prior to its rescue. The committee's chairman, John McFall, accused him of being asleep on the job.
Even though only halfway through his five-year term, Sir John has agreed to leave the Bank when it receives its new powers next spring.
King did not need to threaten to resign to get his way with the latest appointment: the mere suggestion of Britain's central bank losing its Governor during a credit crunch would have been enough to spook fragile markets.
At the FSA, chairman Sir Callum McCarthy is being replaced by Lord Turner, a former head of the CBI, but it will be the Bank that emerges as the new champion of bank regulation.
Until now the FSA has monitored individual banks while the Bank of England has been responsible for the stability of the financial system. Under the proposals about to be detailed by Darling, the Bank will again be involved in micro as well as macro regulation.
Under a special resolution regime, the Bank will be allowed to give covert support to an institution in trouble, either through an injection of finance or by transferring deposits to a stronger bank. The FSA can ask for such action but it will be the Bank that implements the rescue. Further, the Bank will have formal powers to ask the FSA to investigate a particular bank it believes might be in trouble.
The aim is to allow the Bank to move swiftly – and secretly, if necessary – to prevent a repeat of the prevarication that allowed the run on Northern Rock. And in the hope of avoiding the breakdown of communication that marred the Rock's rescue, the Bank will in future have a legal obligation to talk to the Treasury. Other new powers will give it statutory oversight of the country's payment systems.
Darling is also considering allowing the Bank to stop publishing the weekly balance sheet that shows its degree of support to troubled banks. It was this regular announcement that revealed the £26bn of funding provided to Northern Rock.
The Bank has yet to publish its annual report showing its lending to the mortgage bank, however. Although the accounts for the year to February were released in June last year, the 2007-08 accounts have still not been finalised, though they must be presented to Parliament before it rises for the summer recess next week.
For the first time, the Bank is to be given statutory responsibility for financial stability rather than the present informal system. A new stability committee, chaired by King, will be established to run parallel to the Monetary Policy Committee. However, unlike the rate-setting MPC, all members of the new committee will be drawn from the Bank's court – and that governing board is itself to be shrunk from the current 18 members to 12 or fewer, most of them non-executive.
And again unlike the MPC, the new committee will have no targets, saving the Governor the need to write any explanatory letters to the Chancellor.
King, who this month starts a new five-year term as Governor, emerges as the victor of the Northern Rock affair, winning back powers lost to the FSA when Labour took power.
The friction between Treasury and Bank persists, but while Darling is lumbered with a state- owned Northern Rock in the midst of a deteriorating housing market, King will end his term at the Bank in a stronger position than when he became Governor.Reuse content