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Rock retrospective.

Document Cited in Related
Vincent
AuthorHoward, Malcolm
PositionLetters - Letter to the editor

I wasn't impressed by the "Management Accounting--Risk and Control Strategy" article in February's issue, written by the examiner for paper P3. You can have the most sophisticated risk management policies and the most imaginative corporate governance mechanisms and it will still be impossible to identify all the risks.

Had the examiner written this about Northern Rock a year ago, it would have been worth taking note, but it's all so simple with hindsight. If you go back 12 months and see what was known then, the bank had a perfectly reasonable strategy, which was to minimise costs by having fewer branches and to borrow more of its cash from the money markets rather than from depositors.

In living memory, the money markets have maintained equilibrium by adjusting rates. If money was tight, the rate increased; if it was plentiful, the rate decreased. To mitigate the known risk, based on probabilities calculated from historical records, the bank had to ensure that its lending rate covered its highest potential borrowing rate. Liquidity risk under these conditions was covered by ensuring that its mortgage book was sound and that what it lent was secured against assets. Northern Rock actually had one of the safest mortgage books.

The examiner writes: "Northern Rock's managers had assumed that the bank's access to funds would continue unimpeded." Why wouldn't they? How could they possibly have predicted that the US sub-prime mortgage crisis would develop and that the...

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