eFinancialCareers

What is it?

Northern Rock is a UK bank. It offers bank accounts to retail customers, as well as loans and insurance products. It is also one of the UK’s leading mortgage lenders.

In February 2008, Northern Rock was nationalised. Its debt is now treated as debt held by the British government.

What’s it got to do with the financial crisis?

In September 2007, Northern Rock experienced the first run on a British bank since 1866. Northern Rock’s retail depositors began queuing up outside its branches in an attempt to withdraw their money. Queues lengthened as rumours spread that the bank would be unable to give its customers their cash when they requested it. And the longer the queues became, the more inevitable became Northern Rock’s inability to pay – all banks only hold enough cash to cover a fraction of the deposits they hold.

The run on Northern Rock was sparked by its need to borrow an emergency loan from the Bank of England on 12 September. News of the loan leaked out, sparking panic among Northern Rock’s customers. Their rush to remove their money from their Northern Rock bank accounts was only stopped on 17 September, when the British Chancellor of the Exchequer said the UK government would guarantee all existing deposits at Northern Rock. This guarantee was later extended to all new deposits. As a result, the government was exposed to the risk of repaying as much as £30bn to Northern Rock customers if things went wrong.

Shares in Northern Rock subsequently plummeted. In the months that followed, several unsuccessful attempts were made by the government to arrange a sale of Northern Rock to new owners. All fell through. Northern Rock was therefore nationalised.

Northern Rock was particularly susceptible to the credit crunch. It had a penchant for offering risky mortgages: between the end of 2006 and the time that the crunch hit in 2007, Northern Rock quadrupled the number of mortgages it made that were worth more than 100% of the property they covered.

However, the real reason the Rock crumbled was its reliance on short-term borrowing to cover its mortgage lending. While other mortgage lenders used a high proportion of customer deposits to raise the cash reqired for mortgage lending, Northern Rock raised money by forming special purpose entities (SPEs) and selling mortgage backed securities based on the mortgages it already had.

These SPEs were themselves funded by issuing short-term debt. Once the credit crunch started (ie, once BNP Paribas raised the alarm), no one wanted to buy that debt any more. And Northern Rock was in big trouble. As the credit crunch eased, Return to A-Z home page