Bank of England to bail out Northern Rock

 Bank of England to bail out Northern Rock

By Peter Thal Larsen and Chris Giles Thu Sep 13, 8:30 PM ET

The Bank of England will today throw a lifeline to Northern Rock by providing emergency funding to the beleaguered mortgage lender that has fallen victim to the liquidity squeeze in the banking sector.
ADVERTISEMENT

In an unprecedented move, the Bank, working with the Financial Services Authority and the Treasury, will step in to bail out Northern Rock by providing it with a short-term credit line that will allow it to carry on operating.

The rescue, which has been approved by the Chancellor of the Exchequer, is the most dramatic illustration to date of how the British banking sector is being hit by the wave of turmoil that has paralysed the money markets.

It will lift the uncertainty that has been hanging over Northern Rock's future for much of the past month because it could not access the wholesale funding upon which it is heavily dependent.

It will also allow Northern Rock to reassure thousands of customers that their deposits are secure.

Northern Rock is the first institution to be propped up since the Bank, in 1998, revised the rules under which it will act as a lender of last resort to banks in financial difficulty.

The Bank is expected to say on Friday that a similar facility is available to any other institution facing short-term difficulties. However, it is understood that no other banks have asked for financial support.

The move comes after weeks of financial turmoil raised questions about Northern Rock's business model, which relies heavily on raising financing through the capital markets.

The rescue comes just a day after Mervyn King, the Governor of the Bank of England, adopted a tough public stance when he warned about the hazards of bailing out financial institutions that had engaged in reckless lending.

The Bank is acting in its role as a "Lender of Last Resort", which allows it to lend - at a penalty rate - to institutions that can provide good quality assets as collateral.

Executives and regulators are understood to have decided to seek support from the Bank's facility after concluding that Northern Rock would not be able to refinance obligations, including mortgage-backed securities, that are due to mature in the next few weeks.

While other banks have also been squeezed by a sharp rise in short-term interest rates in recent weeks Northern Rock has proved particularly vulnerable to the liquidity squeeze because it has a much smaller deposit base than other lenders.

The Bank will provide a credit line supported by the assets in Northern Rock's mortgage book, which has no exposure to subprime mortgages and which regulators have concluded is sound.

Northern Rock executives are expected to say on Friday that it will try to trade through its difficulties with the help of the facility. However, regulators will be watching closely for signs of unease spreading to other parts of the banking sector.

The rescue makes it almost certain that Northern Rock will have to surrender its independence.

Several banks are thought to have considered buying Northern Rock in recent weeks. However, discussions were complicated by the difficult conditions in the capital markets and by uncertainty over the true value of Northern Rock's shares.

Since hitting their peak in February, shares in Northern Rock have lost half their value amid concerns that the rising cost of wholesale funding would squeeze margins and limit the bank's growth.

On Thursday, the shares closed down 33p, or 4.9 per cent, at 639p.

The bank is set to issue a trading update on Friday describing the impact of the recent market turmoil on its business.

Northern Rock, the Bank of England, the FSA and the Treasury all declined to comment.