The shadow of scandal falls over the Bank of England on Threadneedle Street

This week the Bank of England was embroiled in a criminal inquiry over possible rate rigging during the financial crisis. The affair has also raised hard questions about the central bank’s commitment to transparency

The Bank of England has become embroiled in an investigation that could damage the 321-year-old institution (Reuters)

The Old Lady of Threadneedle Street has entered some uncharted and dangerous waters. It emerged this week that the Bank of England has become embroiled in a criminal investigation – a sensational and deeply damaging episode for the 321-year-old financial regulator.

“It’s terrifying – a very big deal,” said Mark Garnier, the Conservative MP and a member of the Treasury Select Committee. “This is the fifth- biggest economy in the world and its central bank is being investigated by the Serious Fraud Office. Remember [too] that this is the premier banking capital in the world.”

No charges have so far been presented – and may never be. Yet the Bank is already facing tough questions about its handling of the incident and its commitment to transparency.

The fact of the investigation had to be wrestled into the public domain. After probing from a journalist, the SFO confirmed on Wednesday evening that it is “investigating material” passed to it by the Bank last November. This material concerns “liquidity auctions during the financial crisis in 2007 and 2008”.

That admission prompted the Bank itself to release a statement confirming it had commissioned Lord Grabiner, QC, to conduct an independent inquiry into those auctions. Neither the SFO nor the Bank were willing to elaborate on the nature of the material passed over – or what precisely Lord Grabiner was asked to investigate.

But the SFO did confirm to The Independent that this is now a criminal investigation.

The context of that revelation is deeply troubling. A year ago, currency traders under investigation for rate manipulation told Bloomberg they had been informed by Bank officials that it was OK to manipulate markets.

Lord Grabiner was commissioned by the Bank’s Oversight Committee to probe those incendiary claims. He published his report last November, saying he had found no evidence that any Bank official had been involved in unlawful or improper behaviour – although one employee was criticised for failing to “escalate” potentially serious information.

But now it has emerged that the QC was conducting a parallel probe. And the evidence that investigation threw up was clearly sufficiently serious enough to warrant being passed on to the SFO.

Did the Bank commission Lord Grabiner for the second probe based on some new tip-off about potential wrongdoing in liquidity operations – like the accusations over forex? Or did the second probe grow out of the work of the first one? Did Lord Grabiner and his supporting team from the law firm Travis Smith uncover a new area justifying investigation as they trawled through some 66,000 documents and reviewed around 6,700 telephone call made by officials at Threadneedle Street? The fact that Grabiner’s original terms of reference were to examine the period between 2005 and 2013 suggest this is a possibility.

So who knew about the second (or wider) Grabiner probe? The Financial Times had reported on its existence last year. But the Bank had repeatedly refused to comment. The Governor, Mark Carney, was specifically asked about the existence of a second Grabiner investigation as recently as Tuesday, at the Treasury Select Committee. “We don’t provide a running commentary on inquiries that we are conducting, particularly if such commentary might prejudice the effectiveness of those inquiries,” was his answer.

But after the story was finally confirmed on Wednesday, Andrew Tyrie, the head of the committee, revealed he had been informed of the SFO referral back in November.

“This was the right thing to do” he said. “We must now await the outcome of the SFO’s work. The sooner their findings are published the better.”

But the fact that the rest of the TSC was kept in the dark has left at least one member of the committee unhappy. “I specifically asked the Governor about other members of [Bank] staff [implicated in rate-rigging] and it’s disappointing and inappropriate that they didn’t inform us of that,” said John Mann, the Labour MP, yesterday. “Tyrie’s behaved inappropriately and the Governor’s behaved inappropriately. The transparency is palpably lacking.”

Jesse Norman, a Conservative member of the committee, has also expressed concerns over the Bank’s approach to its internal investigations. He has questioned the rigour of Lord Grabiner’s report on forex rigging, saying that the terms of reference were too narrowly drawn by the Bank. “It is simply not appropriate for the Bank to proceed in this way on such a serious matter,” he wrote in a letter to the Financial Times this week.

The SFO would not say yesterday when it expects to decide on whether to take the case further. “It could be months,” said a spokesperson. The Bank may find itself fielding challenging questions about its handling of the affair rather sooner than that.

Who knew? Questions the Bank has to answer

Q. Why the secrecy?

The Bank commissioned Lord Grabiner to investigate possible collusion in forex manipulation. But he was also investigating a quite different matter at roughly the same time. Yet the Bank made no public disclosure of the existence of the second investigation. Why?

“We as a matter of policy don’t provide a running commentary on inquiries that we are conducting, particularly if such commentary might prejudice the effectiveness of those inquiries,” said Mark Carney at the Treasury Select Committee earlier this week.

The Bank says revealing the inquiry’s existence could have prejudiced a possible future trial. But the Grabiner forex inquiry could also have resulted in a criminal investigation and that was made fully public. What is the difference?

Q. What does this say about transparency at the central bank?

If the Bank of England had been a private bank or any other public limited company it would have been compelled to inform shareholders about the fact that it was involved in a criminal investigation.

But Threadneedle Street – a public body – was apparently under no such compulsion. “The Bank has immense responsibilities for monetary stability, financial stability and for micro-prudential regulation. And with these responsibilities comes the need for effective transparency, genuine accountability and robust governance,” said Mr Carney last December.

But when the Bank keep an internal investigation secret, and also the fact that it is involved in a criminal investigation, that will strike many as falling well short of transparent.

Q. Who was kept in the circle of trust?

Andrew Tyrie, the chair of Parliament’s Treasury Select Committee was informed that there was a separate Grabiner investigation commissioned by the Bank. But why was the rest of the committee unaware? Was Mr Tyrie instructed by the Bank not to tell them? If so why?

What Happened? How the taxpayers may have lost out

During the 2007-09 crisis banks feared ruled the entire financial system. Everyone knew there were huge losses hidden on balance sheets as a result of bad loans made over the previous decade. But no one knew which institution was most exposed. As a result banks would not lend to anyone on normal terms.

This was the credit crunch. The Bank of England, like other central banks, was forced to step into the breach with cheap money. It made short-term financing available to enable financial institutions to meet their liabilities.

There were a series of “liquidity auctions” from monetary authorities. Private banks would essentially bid for short-term funding from central banks. We do not know what officials at the Bank of England are suspected of doing. But one possibility is that private banks colluded to offer low bids for the liquidity, which could have saved them all money - and that some at the Bank of England turned a blind eye. Another conjecture is that the loan collateral posted with the Bank by the private lenders was known by officials to be below the quality officially demanded.

If this is what happened it would have meant the Bank of England - an arm of the public sector - selling liquidity to private sector banks at an excessively cheap price.

Another piece of context - which may well be unrelated - was that last year Lloyds Banking Group was fined by the Financial Conduct Authority for manipulating the repo rate, used to calculate the fees paid to the Bank of England for its special liquidity scheme (SLS). Tracey McDermott, the FCA's director of enforcement and financial crime, said that collusion between traders at Lloyds to influence the rate paid to the Bank came “at the expense, ultimately, of the UK taxpayer”. Lloyds was also told to pay £7.8m in compensation to the Bank.