Northern Rock hysteria

"Some customers were queuing outside Northern Rock branches"

Why? Its not going to go broke? It has £113 bn in assets. It is supported by the Bank of England. This bank is not going under. However as the Media like a good scare store and the real story is perhaps a bit too economic for most people to understand people are queuing outside banks.

A traditional bank balances its books by lending out to customers what is deposited by customers. However, there is no need to do this as you can lend out more money if your borrow extra money from the money markets. For example you could have a mortgage for 15% interest, the bank can add a batch of mortgages together and borrow at 10% interest. They can make money on the margin.

However, if jitters cause money rates to tighten the cost of borrowing new loans can increase which will threaten the ability of the bank to take in new business or finance old business. In theory the bank could liquidate some of its assets by passing on mortgages but obviously this makes little sense over the long term. So if the bank cannot raise finance on the money markets they can borrow money from the Bank of England as a bank of last resort This is a way of supporting the banking sector through a difficult period. If the bank did not promise a facility then Northern rock could not carry on business as usual and would have to restructure its debt, which is not the same as going out of business.

In this situation it would be likely that there would be major reductions in new business , saving rates would be cut and the mortgage rate would increase. These measures would have a significant effect on the economy, potentially pushing it into recession. Thus the Bank of England always support the industry and the government.

Northern Rock has not yet used the facility but as it is available they can carry on with business as normal. Absolutely no reason to panic. Finance is all about confidence, this loan gives confidence to the Northern Rock and allows them to continue to act normally.

People should also note that the FSA have strict regulations on liquidity which is the ability of a financial institutions to meet its commitments, which basically means having enough capital.

The FSA had this to say about Northern Rock:

"[Northern Rock] exceeds its regulatory capital requirement and has a good quality loan book"

Which translates the Bank has a solid set of accounts, has not got any dodgy loans that are going to fall through and all is fine.