Easy lies the crown: King snatches victory out of ignominy

Savaged for reacting slowly to the Northern Rock affair, the Governor of the Bank of England has managed to come out of the crisis stronger, winning new powers from the Government and his own choice of deputy. Richard Northedge reports

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.