It was inherent in the mandate of the Bank of England in the 1980s and 1990s, as overseer of UK financial services, that its successes remained hidden in the shadows, while its failures were exposed to the harshest of lights.
Those two decades saw high-profile collapses, including of the Bank of Credit and Commerce International and Barings, which provoked much criticism of the Bank. This led, in 1997, to a new Labour government handing supervision of UK banking to a newly-created Financial Services Authority under the aegis of HM Treasury.
As Chancellor of the Exchequer Gordon Brown simultaneously granted it independence from the government over monetary policy, 1997 saw the biggest change in the Bank of England’s role in its 300-year history.
These events are central to a fascinating new book by Harold James, Making a Modern Central Bank – The Bank of England 1979-2003. James, professor of history at Princeton University and a leading economic historian, lifts the lid on events that prompted an economic and monetary revolution that still reverberates through global finance today.
The book, the events and issues it covers, and the implications of those events to financial markets today, will be discussed during an OMFIF meeting on Monday 23 November which will feature the participation of many of the leading actors in these dramas. They include Mervyn King, Norman Lamont and Ed Balls.
James, who was granted unprecedented access to the Bank’s archives and spoke to many of the leading Bank officials, uncovers an important bank intervention that has remained out of the public realm, until now.
In an extract from the book below, James tells of how in 1991 Midland Bank was close to collapse and the Bank stepped in quickly, effectively and with the utmost secrecy, to save it.
This was the Bank at its best, using its knowledge, financial firepower and absolute authority to shore up Midland, bring in new leadership (no easy task given the personalities involved) and prevent a collapse. Midland’s failure would have cost the UK billions in bail-outs and lost economic activity, and might have spread to a wider banking crisis as happened in the early 1990s in other European countries. A year later, Midland’s future was secured through its takeover by HSBC – a marriage that Bank officials, including the governor, doubted would ever happen.
These revelations prompt a number of questions that are still relevant today. If Brown and the Labour party had known of the Bank’s success in saving Midland, might that have outweighed their concerns about its failures? But how could Brown have known when even senior government and Treasury officials in 1991 had no knowledge of the intervention? If the Bank had remained in charge of supervision of banks in the run-up to the 2008 financial crisis, might it have foreseen some of the problems building up at the likes of the Royal Bank of Scotland, HBOS and Northern Rock and stepped in, saving taxpayers hundreds of billions?
Join us on 23 November to learn more about this defining era in the Bank of England’s history and the impact it is still having on financial markets and the economy today.
Clive Horwood is Managing Editor and Deputy Chief Executive Officer of OMFIF.
In January 1991, Brian Quinn, the Bank of England’s head regulator, concluded that ‘Midland is in, or rapidly approaching, a crisis.’
The public discussion of the Bank of England’s financial supervision in the 1980s and 1990s focused on spectacular failures, Johnson Matthey, BCCI, and Barings. It formed the backdrop to the sense that the Bank had failed.
Gordon Brown, as opposition spokesman, castigated the Bank as ‘a soft touch for a crooked bank’. His first act as chancellor in the New Labour government of 1997 was justified on the basis of the widespread critique. Brown gave the Bank autonomy or independence in monetary policy, but took away financial supervision.
No one in the late 1990s discussed the Bank’s greatest success: the rescue of Midland in 1991 in the midst of a deep recession. The essence of the Bank’s financial stability actions was lop-sided: failures attract enormous criticism, but successes cannot even be mentioned (until the historian ploughs through the records a long time later), because even to admit the fact of a rescue would seriously damage the credibility and business prospects of a financial institution.
Johnson Matthey, BCCI, and Barings were all not systemic, and the Bank then believed – I think correctly – that it was not the task of the Bank to rescue failed banks. On the other hand, Midland was a major UK financial institution. If it had failed, the UK would have joined many industrial countries with serious banking crises that carried a large fiscal cost in the early 1990s.
At the end of 1993, in the wake of a recession and a currency crisis, the fourth largest Spanish bank, Banco Español de Crédito SA, or Banesto, needed to be rescued by the Bank of Spain, with the government injecting 180bn pesetas (£860m) in new capital, and taking over 285bn (£1,370m) in bad assets. In the same year, Crédit Lyonnais required a government rescue that is estimated to have cost the taxpayer £14,000m. Banking crises in Norway (1991) had an estimated fiscal cost of 2.7% of GDP, in Sweden (1991) 3.6%, and in Finland (1991) 12.8%.
The 1990-91 recession had affected profitability at all UK clearing banks, but one was especially vulnerable. Midland had long looked weak, and had suffered major losses on its US subsidiary Crocker Bank in 1983 and 1984. By the beginning of 1991, it looked as if there might be a panic and a run on Midland Bank. The problem lay both in the asset side of the bank and in the high level of funding costs. There were bad debts as a result of the UK real estate market, as well as losses arising from the holding of lower yielding dollar assets against problem country debt.
In January 1991, Brian Quinn, the Bank of England’s head regulator, concluded that ‘Midland is in, or rapidly approaching, a crisis.’ He suggested that a two-pronged strategy was needed, first to replace the top management, and then find a suitable partner for a merger. ‘We must,’ he wrote, ‘give some thought to considering whether Sir Kit [McMahon]’s tenure as chairman [and chief executive in a combined role] has not been a failure and whether his strategy for the group over the last five years has been fundamentally flawed, both in concept and in its execution.’ It would be difficult to merge Midland with another British clearer, but also ‘it is not very obvious where a foreign partner might come from but this perhaps comes of the current depressed conditions on the international banking scene.’
The Bank’s officials thought that Midland, which accounted for some 17% of UK clearing bank deposits, was too big to fail. The danger was that a half-hearted, or not copper-bottomed, declaration of support, would trigger a depositors’ run. In a meeting with Treasury officials, Quinn recalled the experience of Continental Illinois, where a qualified statement of support had been followed after six weeks by a run.
The discussion of Midland’s future was highly personalised. The problem lay in the Bank past of former Deputy Governor McMahon, who seemed at least to the Bank to wish to escalate his current employer’s conflict with the Bank of England. He had repeatedly denounced the high interest rates that followed from the adoption of the European exchange rate mechanism as fundamentally responsible for banks’ problems.
The Bank’s Governor, Robin Leigh-Pemberton, felt that Midland and its chairman might be getting a light ride because many senior officials remembered and liked McMahon from his time as deputy governor. Leigh-Pemberton was also persistently [and, eventually, wrongly] sceptical about Midland’s attempts to merge with HSBC, commenting for instance in 1990 that ‘he did not feel this was terribly solid.’ If the merger went ahead, ‘it would be a case of two-plus-two certainly not making five or six and struggling to make four.’
Immediately, the Bank bought as much marketable paper as it could from Midland (it had some £3-4bn in liquid bills). But beyond that, the Bank prepared a full range of scenarios, beginning with a change of management, though also including public guarantees, finding a bank that would take Midland over, but also nationalisation.
McMahon continued to the last moment to resist the call to step down, and complained that the Bank actions were leading to ‘internal risks.’ The Midland management also complained that another clearer had refused Midland a two-year swap. The Bank of England was in effect ‘taking over the corporate governance of Midland.’
Leigh-Pemberton’s attempt to engineer a change at the top was initially frustrated by the refusal of Bruce Pattullo of the Bank of Scotland to become chairman. He then turned to a London clearer and approached the deputy chairman of Barclays plc, also unsuccessfully. Finally, he asked Brian Pearse of Barclays to take on the role of chief executive, with Sir Peter Walters, a former chairman of British Petroleum, as chairman.
The move was carefully sounded out, with a meeting with the Prime Minister John Major, who authorised the governor to say that taking the job was in the national interest. But the Bank also prepared the way in a highly secretive meeting with partners of Cazenove, the merchant bank, who were summoned in to meet the governor, entering the Bank through a rear door and going into a completely sealed off Parlours. The Cazenove partners explained that the package would not be credible if McMahon were allowed to stay on until his 64th birthday.
After more meetings with the Treasury, the Bank had a draft letter of support prepared in which the Bank might receive an indemnity from the Treasury for a possible rescue operation, involving ‘action to restore the bank’s [Midland’s] capital position, whether by varying retentions policy or by a capital injection or by some other means.’ The Bank also contacted Willie Purves, of HSBC, who felt left out of the negotiations – HSBC had taken a 15% stake in Midland, but now had the intention of reducing it. Purves explained that ‘he had not realised the situation was so grave,’ and worried about taking a chief executive from another clearer.
In the end, the operation to announce the change of management went smoothly. McMahon acknowledged that he had been pushed out: ‘The Bank of England was clearly involved in the search for a new chief executive. I admit that over the years we have made a lot of errors. I hope to find retirement a little more relaxing.’ Initially, the reaction was positive, and there was no need for the Bank contingency plans. But the longer-term future was only really secured with the takeover by HSBC in 1992.