The delicate balance of public confidence

Following the United States mortgage problems which have create ripples of financial unrest all round the world, Britain, in the shape of the Northern Rock Bank, has caught a major cold..and it's an indication of how sensitive is the issue of public confidence.

British banking has been caught out, as Mervyn King, the Governor of the Bank of England pointed out today, by the very measures designed to instill confidence in British banking ie complete transparency.



Northern Rock has been speculating big time in the mortgage market and probably overreached itself when the massive downturn hit the US housing market and Northern Rock was forced to ask the Bank of England for help. It's not the first time this has happened and is not necessarily a sign of disaster. Banks used to get a short term loan and then good management made sure they got back on the straight and narrow.



But this was in the days when Banks could approach the Bank of England discreetly, the terms of the loan could be agreed over coffee and investors would be none the wiser, thus consumer confidence would remain high.

Then the law changed in order to protect consumers and to ensure that all banking business was above board and transparent. The result of this was that the Bank of England could no longer lend Banks money covertly. The law states that all such transactions must be published.

And so the very Acts designed to protect banking worked against it. As soon as news was published that Northern Rock was going to the BOE for funds, so consumer panic began and the long queues of savers seen last week queuing round the block to get their money out despite almost desperate reassurances from the Treasury that all savings would be underwritten by the Government.

The headlong panic has stopped but the crisis is not yet over. Northern Rock has suffered a major blow to its reputation for financial competence and its shares continue to fall prompting rumours of a take-over by one of the big High Street banks.

Many people are saying that there could be a silver lining out of this, in that cheap credit could come to a sudden end and people might have to start living within their means. This in itself carries its own problems of course.

What is absolutely clear is that Britain's much vaunted banking system and its inbuilt consumer protection measures as supervised by the Financial Services Authority, has a massive hole which needs to be filled very quickly. The prime issue is the level of insolvency compensation offered by the FSA should a bank hit the rocks, and this is currently set at only £35,000 per saver.

This is clearly totally inadequate as the value of money goes down over time and there is an urgent need to examine this. A second factor is this issue of published lending. There probably ought to be some reference point which can sanction the bypass of overt lending statistics if it is considered that the BOE as lender of last resort needs to do so in secret in order to sustain public confidence.

It's a delicate balance but one that needs to be dealt with soon or there will be other banks and financial institutions caught in the wake of a panic just like Northern Rock.