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The Northern Rock bank run

By Faisal Islam

Updated on 14 September 2007

Across the country a run on Britain's fifth largest lender after the Bank of England offers Northern Rock unlimited support.

It certainly looks like a bank run - the scenes in London today fulfilled the dictionary definition.

And heading north to Nottingham, and Middlesbrough, the same extraordinary scenes. savers forming long queues to drain their life savings from Northern Rock.

Banking -- an industry built on credibility, confidence and trust. But the Rock looks wrecked even in its home town of Newcastle.

Deposit guarantees should prevent this. But even after an extraordinary unlimited lending facility granted by the Bank of England and agreed by the Chancellor, customers preferred the sight of real cash.

From its roots as a sleepy building society Northern Rock has emerged as a financial revolutionary aggressively innovating in its mortgage lending and borrowing.

Despite its problems the bank is still solvent, it actually has half the proportion of delinquent mortgages on its books compared to other banks.

This is no bailout of reckless lending, but the Chancellor turning back on a tap of funding for its business model, that had been blocked off by the US mortgage crisis.

In the good old days, savers deposited their money with banks and building societies who then lent it to customers in the form of loans or mortgages.

But only a tiny proportion of the money Northern Rock lends comes from its savers.

Instead it's turned to the money markets - borrowing from other banks and financial institutions at market rates.

For years this business model has allowed Northern Rock to borrow cheaply - and in turn offer cheap mortgages - expanding its share of the mortgage business to nearly 20 per cent.

But fears about US mortgage debt have paralysed the money markets ...

causing the rate at which banks borrow from other banks to soar and many institutions to stop lending altogether - which has left Northern Rock's entire business model looking a bit broken.

So now its the Bank of England offering a theoretically unlimited loan, at a penalty interest rate, secured against the value of Northern Rock's prime mortgages.

Talks had been going on for days. Channel 4 News understands that it had been borrowing its funding gap and rolling it over day to day. That was thought to be unsustainable when it appeared that stubbornly high interbank interest rates weren't coming down.

One bank's crisis is another opportunity, but there are at least three other banks that pursued a similar strategy, though aggressively, whose shares have been panned on the markets.

The Bank of England is clear today's action was taken not to save Northern Rock, but to prevent wider serious economic damage. It's done enough to keep Northern Rock trading normally for now, but it looks unlikely to survive as an independent company.

For the Bank of England this is just the beginning of an unprecedented challenge a tightrope between financial stability and undeserved lifeboat rescues.

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