Examination of Witnesses (Questions 400
TUESDAY 16 OCTOBER 2007
Q400 Mr Fallon: You do not now regret
Mr Applegarth: It was a very sound
decision. It had no relation to what hit us. What hit us was the
freezing of global liquid markets.
Q401 Mr Fallon: Your business model,
Dr Ridley, was described by the FSA Chairman as "extreme".
You were borrowing 75% of your funding from the capital markets;
you failed to insure against any increase in the inter-bank rate;
you failed to hedge the period between taking out a mortgage and
its completion, because presumably you thought rates had peaked.
This was not banking; this was a heavily leveraged bet on interest
rates was it not?
Dr Ridley: I think it is worth
clarifying what the funding side of our balance sheet was. It
is true that we had a smaller retail deposit book than many other
institutions, although there are many like us overseas. As the
Chairman of the FSA also said, in terms of the short and medium
term wholesale funding, as a ratio of our balance sheet assets,
we were not an outlier. Most of our wholesale funding was in the
form of securitised bonds and covered bonds, which are long-term
funding. The average maturity is longer than the average life
of a mortgage on our books.
Q402 Mr Fallon: But why did you not
see the risk of capital markets closing to you? Why did you not
insure against the danger of illiquidity?
Dr Ridley: We saw that there was
a risk of tightening in the credit markets and we prepared for
that. What we did not expect was that there would be no flight
to quality in that process. In other words, we expected that as
markets became tighter and as pricing for risk changed that low-risk
prime UK mortgages (and we have below half the industry average
of arrears on our mortgage book) and such a low-risk book would
remain easier to fund than sub-prime mortgages elsewhere. That
is why we were very determined to keep the credit quality of our
book high, in order to be able to attract funding.
Q403 Mr Fallon: But a very high proportion
of your funding was dependent on the capital market, a much higher
proportion than other lenders?
Dr Ridley: We were dependent on,
as I said, the wholesale markets but also the securitisation market
and the covered bond market. We deliberately diversified our funding
platform so that we would have those three different types of
funding and indeed a diversified programme within the wholesale
funding, and geographically we had programmes in the United States,
Europe, the Far East, Canada and Australia. That was deliberately
so that if one market closed we would still have access to others.
The idea that all markets would close simultaneously was unforeseen
by any major authority.
Q404 Mr Fallon: But a heavily leveraged
bet on the movement of interest rates and on capital markets remaining
open for an over-exposed model like this seems to me a fairly
basic banking error, is it not?
Dr Ridley: We were subject to
a completely unpredicted and unpredictable closing of the world
credit markets. Our model was entirely transparent to the market
and to the regulator. It was discussed regularly with both and
it was not at the time seen as running a particularly high risk
in terms of liquidity.
Q405 Mr Fallon: But it was your duty
as Chairman and as a Board to ensure that your bank was liquid.
Dr Ridley: We reviewed liquidity
regularly and we reviewed our policy on liquidity and our policy
on funding regularly.
Q406 Mr Fallon: But you were wrong?
Dr Ridley: We were hit by an unexpected
and unpredictable concatenation of events.
Q407 Mr Fallon: So you are the Chairman
of a bank that ran out of money and that caused the first bank
run in this country for 150 years; you have had to borrow billions
of pounds of public money from the Bank of England; you have damaged
the good name of British banking; why are you still clinging to
Dr Ridley: I would like to say
that what has happened has been extremely distressing to us, as
it has been to our other stakeholders, shareholders, employees
and creditors. In view of what has happened I am extremely keen
to try and turn the situation round and develop a stable future
for Northern Rock. I am working night and day to achieve that.
I serve at the behest of the Board and if they think that they
can do better by asking for my resignation, it will be available
Q408 Mr Fallon: But this is a humiliation.
Has none of the Board any sense of honour? Has nobody offered
Dr Ridley: I would like at this
point perhaps to suggest that Sir Ian Gibson answers that question.
Q409 Chairman: No, you answer it
Dr Ridley, that is what you are here for.
Dr Ridley: Yes indeed, I was going
to say I will give a quick answer to it first. I have made it
clear to the Senior Independent Director, as is his role, that
my resignation is available to him as soon as he thinks it is
in the interests of the company, its shareholders, creditors,
employees and other stakeholders that I go.
Q410 Chairman: You did say that you
discussed the risk on this issue with the Chief Executive on 10
August; that is correct?
Dr Ridley: Correct.
Q411 Chairman: And that this was
unpredicted. You have said that two or three times to Mr Fallon.
Dr Ridley: Yes.
Q412 Chairman: But were you aware
of the Bank of England's April 2007 Report on Financial Stability
and were you aware of the Financial Risk Outlook from the
FSA in January 2007?
Dr Ridley: Yes, I was aware of
both of those reports.
Q413 Chairman: Did it influence Board
Dr Ridley: It did influence Board
Q414 Chairman: What did you do from
January to April?
Dr Ridley: We did a number of
things. We prepared to sell some of our asset books, as you will
know because of announcements we made at the half yearour
commercial loan book and our unsecured loan book and
Q415 Chairman: I would suggest to
you, Dr Ridley, you failed because if you look at the Bank of
England statement it is very clear, in late April it says that:
"Recent developments in the US sub-prime mortgage market
have highlighted how credit risk assessment can be impaired in
these markets and how participants can be hit by sharp reductions
in market liquidity. It is important therefore that firms stress
test and we take them into account ... " That was in April
so what you did from April to 10 August seemed to have no effect
whatsoever on the position that you found yourself in, so you
did not take corrective action that was successful?
Dr Ridley: As you say, that report
was about the pricing for credit risk in the markets as well as
liquidity and we ensured that our funding was
Q416 Chairman: But Dr Ridley, let
us forget about the words here, this talks specifically about
reductions in market liquidity. You are telling us that this was
unpredicted, but this was informed to you by the Bank of England
in April, you were warned, and from April to 10 August you did
not have a successful strategy, is that correct, or otherwise
you would not have found yourself in this position?
Dr Ridley: We were not warned
of a complete freezing of all global liquidity markets.
Q417 Chairman: Let me just read it
to you again. It says here " ... how participants can be
hit by sharp reductions in market liquidity". If that is
not a red alert warning I do not know what is a red alert warning.
Dr Ridley: There were sharp reductions
in liquidity after 9/11 in 2001. That lasted for a matter of days.
Our model was extremely robust in those conditions. What was not
expected was that all global markets would shut down and remain
shut down for as long as they have.
Q418 Chairman: So really what you
are saying to us is that the corrective action you took from April,
if there was corrective action, was not sufficient to avert this
Dr Ridley: The corrective action
we took from April was designed for a tightening of the credit
markets and a tightening of liquidity in those markets; it was
not designed for a complete shutdown of the global markets.
Q419 Chairman: It said "sharp
reductions in market liquidity". In other words, it is a
real warning and you did not seem to take up what that meant and
therefore found yourselves in this humiliating position on 10
August. That is really the answer to the Committee.
Dr Ridley: We were in constant
dialogue with the FSA.
Chairman: We will go on to that later
on. The main point is made there. Colin?