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Northern Rock may have borrowed almost £13bn from Bank of England

Northern Rock may have borrowed almost £13bn from the Bank of England, says New Star economist Simon Ward.

“Other assets” on the BofE’s balance sheet rose by a further £2.3 billion in the week to October 10, bringing the total increase since the run on Northern Rock started to £12.9 billion.

Ward says that this is the best available estimate of the extent of the Bank’s support to the troubled mortgage lender.

The weekly increase has slowed from £2.9 billion in the week to October 3 and £4.9 billion in the prior week.

Ward says that the continuing erosion of Northern Rock’s funding base explains the Government’s decision this week to extend its guarantee to new retail deposits.

The BofE’s injection of funds into Northern Rock has contributed to an easing of money market conditions in recent weeks. The banking system’s reserves at the Bank rose from £19.8 billion on September 12, just before the run on the mortgage bank, to £29.0 billion on September 19 and £29.2 billion on September 26 before falling back to £26.8 billion on October 3 and £20.8 billion this week.

Three-month interbank interest rates fell from 6.90 per cent to 6.27 per cent over the same period. Northern Rock has used the funds advanced by the Bank at a penalty rate to repay its retail depositors and other creditors. Ward points out that a small portion will also have been needed to fund mortgage commitments.

Ward says that rather than stash cash under the mattress, these customers have mostly redeposited their savings with other banks and building societies, which have thereby enjoyed an infusion of liquidity without having to pay the Bank’s penalty rate for emergency borrowing. This Northern Rock liquidity effect helps to explain why banks have spurned the Bank of England’s offer to supply them with additional three-month funds based on looser collateral requirements but at an interest rate at least 1 per cent above Bank rate.

In effect, Northern Rock’s shareholders have paid the penalty demanded by the Bank to supply the banking system as a whole with greater liquidity.

Ward suggests that it could also be argued that the current structure of incentives has created another form of “moral hazard”: by refusing to lend to Northern Rock, other banks have forced the Bank to supply additional liquidity, which they have been able to access at non-penalty rates.

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