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Rock follies

It was not difficult to decide the topic for this column. Northern Rock has dominated the headlines since last Thursday evening, when the BBC broke the news that the bank had arranged an emergency facility from the Bank of England although it did not draw on it last week.

As part of the regulatory process, Northern Rock will have kept both the FSA and the Bank of England very fully informed of its liquidity position, probably on a daily basis as the situation deteriorated.

With the three-month Libor market being virtually closed to most banks, Northern Rock will have had to rely increasingly on overnight funds – not exactly an ideal way to fund longterm mortgages.

Most readers of this column will know that the Bank of England could not afford to let a bank like Northern Rock, with 140,000 depositors, go under, despite governor Mervyn King playing hardball.

The Government also now has far too much political capital invested in Northern Rock, after all the Chancellor’s assurances, to allow it to fail.

Alastair Darling claimed on the Today programme that he only knew about Northern Rock’s problems from the middle of last week. If this is really true, he has been asleep on the job.

Judging by the scurrying of King and others in and out of a meeting on Friday, September 7, that may have been the day that the Bank of England started to get really worried about Northern Rock.

The governor has a difficult path to tread. He has to make it clear that the Bank of England will not prop up banks and other deposit-taking institutions that have been lending recklessly while maintaining confidence in the market – one of its statutory roles – by supporting banks like Northern Rock which have a sound loan book but a short-term funding problem.

No doubt, the latest of the regular, normally cosy, meetings between King and senior executives of the major banks will have been rather more fraught, as the impact of the credit crunch has got worse by the day.

The Fed and the European Central Bank have pumped tens of billions into the banking system to provide liquidity but the Bank of England has only provided a few billion – pocket money in this context. That is why the spread between the official rate and the market rate is much wider in sterling than for the dollar or euros.

The longer the credit crunch continues, the more likely it is that Northern Rock will not be the only bank needing support. The thought of this may encourage the Bank of England to make a serious amount of liquidity available in the near future.

However, if the Bank of England had failed to provide the secured short-term facility to Northern Rock and if it had run out of cash, the ripple effects through the banking system – and not just in the UK – would have been unpredictable, especially as many savers obviously do not trust the words of our Chancellor, which says a lot about trust in politicians.

Ray Boulger is senior technical manager at John Charcol

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