Northern Rock Bank in Crisis
Northern Rock is an important firm in North East of England because it offers full-time employment for 4, 811 employees globally (2007a). It also employs 1,125 part-time employees, majority is women. According from Dr. Matt Ridley, Chairman of Northern Rock, it has added 3,500 jobs since 1997 contributing to the £7.9billion financial and business services sector such as banking, financial services, insurance, contact centers, accountancy, and legal services in North East (Buiter, 2008). However, after the massive financial crisis in August 2007 the firm has a lot to recover.
After Northern Rock demutualized in 1997, it had £15.8 billion assets on consolidated basis which has increased in 2006 to £101 billion from secured lending on residential properties. By the end of 2006, the assets had increased up to 89.2% on residential mortgages but the growth is not based from poor quality assets. Mervyn King of Bank of England supports the bank is careful in monitoring the lenders (Buiter, 2008). In order to maintain the growth in the assets, Northern Rock began borrowing money from wholesale markets and adopting an ‘originate to distribute’ structure of funding. In this model, the loans of the banks do not reach maturity but instead sold to investors as loans. It created Granite securitization which carries 50% of its funding. The bank’s wholesale funding increased but not retail funding which has grown only £22.6 billion in 2006. Retail deposits and funds had fallen to 22.4% in 2006 from 62.7% in 1997, which is considerably lower than the other banks such as Alliance and Licester with 43% and Bradford and Bingley with 49% (Buiter, 2008).
The rapid growth in Northern Rock’s business in early February 2007 is surprising but it got even more surprising after global shock in the financial system. In September, it has been the center of news after facing a massive financial crisis. It started after the Northern Bank engaged in short-term borrowings for lending in longer periods. However, it was not able to replace those borrowings and borrowed from the Bank of England instead (2007). The rate of three-month loan hit above the emergency lending rate of the Bank of England which is 6.75%. It reached 6.7975% which means that British banks are unwilling to lend money to each other. It has been the highest rate of lending in the London Interbank Offered Rate (Libor) (2008b) The bank is not expecting such event and resulted to a massive crisis that could take many years to recover.
The bank’s method of maintaining such as transparency and high-quality assets could not preserve liquidity. Unlike the Countrywide in the United States which had paid millions of dollars for liquidity policy insurance, Northern Rock did not pay any insurance that is why the liquidity offered by the Bank of England is not free. The same crisis with the Countrywide Financial was compelled to borrow billions of dollars and loss 13,000 jobs. Northern Rock too fears the same job loss up to 1,000 (Walayat, 2007). Applegarth trusted on their funding platforms as their insurance, however those are not enough to cover all their losses (Buiter, 2008).
In order to save Northern Rock, Virgin Group offered a £11 billion repayment of the £25 billion debts from the Bank of England and the rest to be paid for three years. Another offer came from the Olivant group who is ready to pay up to £15 billion. However, the chief executive of the Northern Rock resigned in December. The shareholders of the bank then decided to schedule an emergency meeting to discuss the crisis. The rescue of Virgin Groups seems to be the choice of Northern Rock however this could result to job loss of up to 1,000. The government does not agree instead demands that Virgin Groups increase its offer or else it will end to the bank’s nationalization. The Northern Rock proposed to sell its shares to add more money to the bank up to £700 million but the customers are not satisfied to either of those proposals which ended with the decision of Chancellor Darling into nationalizing the bank (2008b).
The directors of Northern Rock are now replaced because of the difficulties experienced by the bank which has become dependent on high-risk business strategy, short-term and medium-term wholesale funding, and absence of insurance. The Chairman of the Board, Chairman of the Risk Committee, non-executive members of the Board, and the senior non-executive director all failed to plan and secure Northern Rock liquidity. Thus the bank became susceptible to liquidity pressures in August 2007 (Buiter, 2008). The Bank of England and FSA also both failed to supervise banks especially those with financial difficulty. “The failure of Northern Rock, while primarily a failure of its directors, was also a failure of its regulators,” John McFall, Labour chairman said (Inman, 2008).
There are several adjustments reviewed by the HM treasury, Financial Services Authority (FSA), and the Bank of England on its January 2008 report Financial stability and depositor protection: strengthening the framework related to the Northern Rock bank crisis. The following are: (1) strengthening of the financial system domestically and internationally, (2) reduce, (3) reducing the impact of failing banks, (4) deposit insurance, and (5) strengthening the Bank of England and improving the Tripartite Arrangement (2008a).
The report by Willem Buiter, known professor on economics and adviser of financial institutions include a history of the Northern Rock, its assets and liabilities as stated above and also the other issues relevant to the banking system in the UK such as the tripartite arrangement. They are not prepared enough for the crisis of Northern Rock even after a weakness in the Memorandum of Agreement has bee identified, the effort on adjusting that weakness is not enough. Communications to the public about the conditions of an event is not fully satisfied by the FSA, the Treasury and the Bank of England which did not prevent the public of queuing for their money (Buiter, 2008).
The report also has sound recommendations for the Northern Rock and for the government. The replacement of the Northern Rock Board members is needed at this point. The directors are responsible for the failure of not preparing for such crisis and engaging in financial strategies that are insufficient to rescue the bank. The FSA also failed to regulate the weakness in the funding model of Northern Rock even after being warned of the risks in the bank’s rapid growth. The Chief Executive of Northern should be chosen carefully based not only from experience but also professional qualification. It is recommended to conduct a review of the qualifications of the rest of the directors in firms like Northern Rock (Buiter, 2008).
The Northern Rock should have a deposit insurance scheme so that in cases like this, the government does not need to rescue the bank’s depositors. The co-insurance that Northern Rock has should not be used again in protecting their depositors because it is not an effective measure. The compensation limit of Northern Bank which is £35,000 should be ‘indexed to a measure of inflation’. Reforms on the leadership of Tripartite authorities must be discussed to ensure that major decisions are clarified. The Bank of England should not take the responsibility of rescuing failing banks (Buiter, 2008).
The government should be responsible in monitoring financial institution like Northern Rock, which has used the taxpayers’ money, and its activities. The event has greatly damaged the reputation of the UK financial services industry, the Bank of England, the Treasury and the FSA. The lessons learned from this should be acted upon immediately and the changes should be implemented as soon as possible. There is a continuous problem in the global financial markets and preventive measures should be done to minimize the effect in UK (Buiter, 2008).
BBC News 2008, Timeline: Northern Rock bank crisis, viewed 6 May 2008, <http://news.bbc.co.uk/1/hi/business/7007076.stm>.
Buiter, W. 2008, The Run on the Rock, VoxEU.org. viewed 6 May 2008, <http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/56/5605.htm>.
Inman, P. 2008, MPs blame watchdog for Northern Rock. Guardian News and Media Limited viewed 6 May 2008, <http://www.guardian.co.uk/business/2008/jan/26/northernrock.creditcrunch>.
PRLog.Org 2007a, Northern Rock, viewed 6 may 2008, <http://www.prlog.org/10037900 northern-rock-plc-swot-analysis-new-business-publication-announcement-from-report buyer.html>.
Telegraph Media Group Limited 2007b, Q&A: Northern Rock, bank in crisis, viewed 6 May 2008, < http://www.telegraph.co.uk/news/uknews/1569780/QandampA-Northern Rock%2C-bank-in-crisis.html>.
Walayat, N. (2007) Northern Rock Bank Run, broker Recommendations and House Price Crash. Market Oracle. viewed 6 May 2008, <http://www.marketoracle.co.uk/Article2141.html>