REVIEW OF THE BANK OF ENGLAND’S PROVISION OF EMERGENCY LIQUIDITY ASSISTANCE IN 2008–09 Report by Ian Plenderleith Presented to the Court of the Bank of England October 2012 Introduction Introduction 1. This Review examines the actions of the Bank of England at the height of the financial crisis, around the collapse of Lehman Brothers, to provide emergency liquidity assistance (ELA) to HBOS and Royal Bank of Scotland in 2008–09. It is one of three reviews commissioned by the Court of Governors of the Bank on 21 May 2012. 2. The terms of reference for the Review (set out in full in Appendix 1) specify that its purpose is to learn lessons to inform the way the Bank conducts ELA operations for individual financial institutions. Specifically, the Review is charged with examining: The basis of the decisions to provide ELA to each firm concerned; The governance arrangements within the Bank for making those decisions; The structure and terms of each ELA operation; The effects of those operations on the institutions concerned and on overall financial stability; The capability of the Bank to plan, implement and manage those operations. 3. Overall, the Review is charged with examining how the Bank discharged its responsibilities as lender of last resort in a crisis and making recommendations for the conduct of any such operations in the future. 4. The Review addresses this remit by examining each aspect of the Bank’s ELA operations in 2008–09 in turn. At each stage, an assessment is made of the effectiveness of the Bank’s actions in the circumstances of the time; and, looking forward, recommendations are made at various points on issues the Bank may need to consider for the conduct of any future ELA operations. For ease of reference, the 28 recommendations are listed at the end of the main body of the Review. 5. Chapter 1 provides details of the main features of the ELA extended to HBOS and RBS and, as relevant background, a summary of the other principal measures taken by the Bank and the Government in 2008 to address the crisis and of significant subsequent changes made in response to the crisis in the statutory and regulatory framework and in the Bank’s framework for liquidity insurance. Appendix 3 describes these changes in more detail, and Appendix 2 provides details of the course of the financial crisis that gave rise to the need for ELA. 6. The next two chapters (Chapters 2 and 3) look at the run-up to the need to provide ELA and examine the Bank’s state of readiness ahead of the need crystallising in October 2008. 7. Four chapters (Chapters 4–7) then examine successively the basis on which the decision to extend ELA was taken, the terms on which ELA was extended, the governance and decision- making process surrounding the ELA operation, and issues relating to disclosure. 1 Introduction 8. Chapter 8 offers an assessment of the effectiveness of the operations. A concluding chapter (Chapter 9) looks forward and examines the future role that ELA might need to play, as part of the Bank’s wider lender of last resort function, and how that function might be exercised. 9. No review of the Bank’s ELA operations in 2008–09 could be conducted without taking full account of the immediately previous occasion on which the Bank had to extend ELA, to Northern Rock in 2007. The terms of reference for this Review provide for it “to build on the lessons learned in relation to the ELA provided to Northern Rock in 2007, as set out in the Treasury Committee’s report, The run on the Rock.” The lessons the Bank learned from its experience of that episode are examined at relevant points throughout this Review and are drawn together in Appendix 4, which addresses each of the relevant conclusions and recommendations in the Treasury Committee’s report. 10. In conducting this Review, I have had full and unrestricted access to the Bank’s records, which has greatly facilitated my work. The Review has also benefited from interviews with many of the main participants in the events of 2008–09 (both inside the Bank and outside), as well as with a number of those within the Bank who would be involved in an ELA operation today, and I greatly appreciate the time they have made available to provide clarification and to respond to questions. A list of those interviewed is in Appendix 6. 11. I have also had immensely valued assistance from the indefatigable Support Unit provided by the Bank. Particular appreciation is owed to Antonia Brown and Gareth Ramsay for the unfailing support, input, challenge and insight they have provided at all stages of the Review. Ian Plenderleith 18 October 2012 2 Contents Contents Introduction ............................................................................................................................................ 1 Contents .................................................................................................................................................. 3 Executive Summary ................................................................................................................................. 4 Chapter 1: Background ......................................................................................................................... 16 Chapter 2: Horizon scanning ................................................................................................................. 25 Chapter 3: Planning for ELA .................................................................................................................. 36 Chapter 4: The decision to extend ELA ................................................................................................. 41 Chapter 5: Terms of the ELA ................................................................................................................. 48 Chapter 6: Governance and decision-making ....................................................................................... 60 Chapter 7: Disclosure ............................................................................................................................ 68 Chapter 8: Effectiveness of the 2008 ELA operations ........................................................................... 74 Chapter 9: ELA in the future and the Bank’s lender of last resort function ......................................... 76 Recommendations ................................................................................................................................ 80 Appendix 1: Terms of reference for the Review ................................................................................... 84 Appendix 2: The course of the financial crisis ...................................................................................... 85 Appendix 3: Changes to the statutory and regulatory framework and the Bank’s framework for liquidity insurance ................................................................................................................................. 89 Appendix 4: Lessons from The run on the Rock .................................................................................... 94 Appendix 5: Past episodes of lender of last resort by the Bank of England ....................................... 101 Appendix 6: List of people interviewed in the course of the Review ................................................. 104 Appendix 7: Glossary .......................................................................................................................... 106 3 Executive Summary Executive Summary Emergency liquidity assistance extended to HBOS and Royal Bank of Scotland 1. In October 2008, as the financial crisis intensified rapidly following the failure of Lehman Brothers the previous month, HBOS and the Royal Bank of Scotland (RBS) received emergency liquidity assistance (ELA) from the Bank of England (the Bank) on a large scale, amounting at its intraday peak to £61.5 billion: HBOS first received ELA on 1 October 2008 and at peak on 13 November had drawn £25.4 billion. HBOS made final repayment of the facility on 16 January 2009; RBS first received ELA on 7 October 2008, initially in dollars, but subsequently from 10 October also in sterling. Its use of the dollar facility peaked at $25 billion on 10 October, and of the sterling facility at £29.4 billion on 27 October. RBS made final repayment of ELA on 16 December 2008. 2. The sterling ELA took the form of collateral swaps, under which the Bank lent the two banks UK Treasury bills (T-bills) against unsecuritised mortgage and loan assets. The structure was similar in form to the Special Liquidity Scheme (SLS), under which the Bank had been providing liquidity against an extended range of collateral on a market-wide basis since April 2008. The Bank charged a fee of 200 basis points on amounts drawn. The Bank received an indemnity from HM Treasury (HMT) for any additional amounts drawn after 13 October. Before that indemnity was put in place, the full £51.1 billion of the Bank’s exposure at that date was not indemnified. Even after the indemnity was in place, the Bank remained unindemnified for £50.9 billion of its peak intraday exposure of £61.5 billion on 17 October. The ELA operation was conducted covertly; it was publicly disclosed on 24 November 2009, just over a year after it was initiated. Background to the ELA operation 3. ELA took place against the backdrop of the global financial crisis, which had precipitated the failure of Northern Rock in September 2007 and had intensified significantly after the failure