From the morning of september 14, 2007 to the week after, queues of customers formed in front of Northern Rock local branches across the UK. From Friday to Monday, nearly £2 billion were withdrawn from customers’ accounts. Northern Rock is a kind of textbook-example of bank runs: if other customers withdraw their deposits, it is rational for me to withdraw my deposits. Given that only a fraction of customers’ deposits is liquid, this is a clear recipe for bank failure. The government finally needed to nationalize the bank to fully guarantee the deposits and protect other banks from failure.
Northern Rock had a 19% mortgage market share in June 2007. It is a significant player on this marker, with 1 million savers, 800,000 mortgage holders, 180,000 shareholders and 6,000 staff.
Most of Northern Rock’s lending is financed by borrowing on money markets (61%), compared to 33% at HBOS, 16% at Lloyds. This makes Northern Rock much more sensitive than other banks to short-term fluctuations of the market since money market investments are more liquid and riskier than other investments.
So, on september 13, 2007, Northern Rock calls the Bank of England to provide emergency funding, as a consequence of its recent difficulties and its inability to borrow from other banks. The story could basically end here. Emergency funding, guaranteed accounts; full stop.
But,interestingly, the Treasury Select Committee Chairman John McFall declares:
I don’t think customers of Northern Rock should be worried about their current accounts or mortgages. The fact that the Bank is willing to act as a lender of last resort should be reassuring, because it means they think the problems are temporary.
This basically bootstrapped the bank run. The Financial Times said the “the rescue is the most dramatic illustration yet of how Britain’s banking sector has been hit by the turmoil in the world’s markets”. It is tabloids who probably inspired the greatest fear amongst customers: the Daily Telegraph (tabloid?) warned that shares in Northern Rock will plunge, worrying thousands of homeowners.
On the morning of september 14, hundreds of customers formed queues in front of London branches of Northern Rock to withdraw their deposits. Despite the youthful “run” that the name “bank run” suggests, customers were mostly gray-haired elderly customers; they thought that it was wise to withdraw now rather than later. Bloomberg was reporting from the Maddox Street Branch. “I am going to take out the lot, every penny”, said William Gough, 75. The crowd attracted other customers who had no idea that Northern Rock had difficulties. One customer went online to check his account, and realized the website was down. This was officially due to the high number of requests. But the customer then decided to go to his local branch, and soon discovered that everyone was taking his money out. So, he queued, and withdrew his money.
Popular press commented on the very “British kind of panic”, polite queues. But nevertheless these queues made the situation of the bank even more difficult. A good reaction for each customer — taking your money out — just makes the situation of the bank even more difficult. Between Friday and Monday, nearly £2 million were withdrawn. Local branches opened at 8 o’clock on Monday instead of 9. And this is the right reaction: if customers are confident they can easily get their money out, there is a good chance they will stop running to do so!
But employees do not have a personal incentive to let them take their money out: they are also stakeholders because they may lose their job. This is again where individual rationality conflicts with common interest. The BBC reported that there had been threats of physical violence and in one instance, in Cheltenham, the manager was barricaded in her office.
The week from Thursday 13 to Tuesday 18 was extremely difficult for Northern Rock. Shares plunged, from slightly above £6 at the beginning of september to around £2 when the crisis happened. This is a 66% loss. On Tuesday September 18, 2007, Chancelor Alistair Darling announced the Bank of England would guarantee all existing deposits. This made the queues disappear, and the bank’s shares rose by 8%. The number of calls to the bank was divided by 10, and online web services were restored.
However share prices still fell in the next five months, and other banks in Europe or across the pond felt the consequences of the mortgage crisis. The trade of shares of Northern Rock was suspended in February, and the government finally nationalized the bank. If Northern Rock fails now, it will cost £3,600 per taxpayer.
What are the reasons for Northern Rock’s near failure? Well, the bank did not have a rock-solid balance sheet. Its heavy reliance on money markets and short term loans made its assets very risky; much more than other major UK banks. Combined with the increasing rate of default on mortgages, it is not surprising that Northern Rock was the first bank to experience difficulties.
Customers’ behavior made the situation even more difficult. By running to get their money out, they put an even greater pressure on an already weak bank. The Bank of England does not require banks to have any liquid reserve, and the Financial Services Authority (FSA) did not realize that the bank held mostly short-term assets on money markets. Thus the last resort against bank runs was the emergency lending facility of the Bank of England and, ultimately, nationalization — which just means that the cost of Northern Rock’s bankruptcy could be paid by all UK citizens..
