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The Failure Of Northern Rock In The Light Of Banking Economics And Regulation

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The Failure of Northern Rock in the Light of Banking Economics and Regulation

Introduction

Increasing global connectivity and integration in today’s world ensures that almost any serious problem has worldwide ramifications. The global financial system can serve as a key example of this phenomenon. Very recently, Britain’s fifth-largest mortgage lender Northern Rock was rescued by emergency funding from the Bank of England. This made the Newcastle-based firm the highest profile UK victim of the global credit crunch that had been triggered by the sub-prime mortgage crisis in the US. The bank run on Northern Rock that followed was unprecedented in recent UK monetary history. The Overend Guerney crash of 1866 was the last recorded bank run in the UK, before Northern Rock lost over £2 billion, starting on the 14th of September 2007.

Background

The run on Northern Rock can be considered as the most vivid indication of the contagion that consumed the financial markets around the world. The company did no overseas lending. Nevertheless, the spill-over effects of the failing US mortgage market sealed the fate of the company when the money markets that Northern Rock had depended on for years crashed at the start of August 2007.

The sub-prime mortgage market crisis started in the United States in the fall of 2006 and took hold as a global financial crisis by July 2007. Due to innovations in securitization, the risks from these sub-prime mortgages had to be shared more broadly with investors which essentially led to the ripple effects in the world-wide economy. The mortgages are generally repackaged into a variety of complex investment securities which are bought by institutions to diversify their portfolios. In the case of the U...

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...ultimate fate of Northern Rock is still undecided although a consortium led by the Virgin Group is the bank’s preferred bidder. Virgin contends to re-brand the bank as part of the Virgin Money business and proposes the repayment of £11 billion of the £25 billion loan that the Bank of England has lent to Northern Rock. Although some call for the nationalisation of the bank in order to secure saver’s deposits and provide affordable mortgages, the real debate revolves around the changes that have to be made in legislation and the regulatory issues that have to be addressed. Considering that a country’s financial system is now completely integrated into one global scheme and is subject to the interdependance within the system, the price is too great for the economy of any country for there to be any allowance of irresponsible risk on the part of an individual institution.
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