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Business & Finance Series: Expert Comment

10 years since Northern Rock nationalisation

What has changed and what risks remain?

by Amy Ripley (Senior Communications Officer)

It’s been 10 years since the then Labour Government nationalised Northern Rock, taking the bank into state ownership.  Academics from Cass Business School discuss what has changed since then and what risks remain for the UK financial industry.

Collapse ignites financial crisis

Professor Andre Spicer explains how the collapse of Northern Rock was one of the sparks which ignited the financial crisis.

“It showed the business model of borrowing from wholesale market to lend on the retail market had significant risks and showed up the scale and extent of risky lending which had taken place across the industry. It also led investors to begin doubting major financial institutions. Initially that doubt was targeted at upstart institutions like Northern Rock. Only a year later, this doubt spread to the major banks.

“The collapse of Northern Rock also lauded the groundwork for the ethical scandals like LIBOR and FOREX rigging which followed the financial crisis. In a market where banks were under pressure to survive, unethical behaviour became rife.”

Professor Spicer said Northern Rock wasn’t a typical bank run.

“When retail investors began withdrawing their money on 14th September 2007 the bank was already in trouble. This was because its funding had already dried up in the global credit markets.

“10 years on, many of the factors which lead to the Northern Rock collapse have been fixed. Banks are forced to hold more capital on their balance sheets, they have tried to get rid of high pressure sales tactics, there are mechanisms to hold senior bankers to account and regulators spend more time monitoring systemic risks. However some factors remain unresolved: failures of auditors and credit rating agencies, reliance on a small range of business models, and an inability to retain lessons from past crises.”

Lessons learned and new risks

Dr Francesc Rodriguez Tous discusses the two important lessons learnt since the collapse and nationalisation of Northern Rock.

“First, the liquidity of financial institutions plays a key role for systemic risk. Northern Rock showed that a bank can be relatively solvent yet completely illiquid.  As a result, the new banking regulation imposes liquidity requirements to banks, hopefully reducing the probability of having a similar case in the near future.

“The second lesson is that we need an authority in charge of these cases.  During August and September 2007, it was not clear who was supposed to take care of Northern Rock’s problems: was it the Bank of England, the Financial Services Authority, or the Treasury? This has been changed and it is now the Bank of England who is both the prudential regulator and supervisor and the resolution authority.

“In short, I do think that the main lessons from the Northern Rock’s failure have been learned—a different issue, however, is if they will be forgotten soon.”

Dr Rodriguez Tous said new risks to the UK financial sector will be from unexpected areas.

“I don't think that the biggest threads to the UK financial sector will come from somehow “expected” parts of the system.  For example, buy-to-let mortgage lending and car loans are well supervised by the Bank of England.

“The major threads are unexpected, or from difficult-to-hedge risks. Cyber risk is an obvious example; risks from losing certain businesses due to Brexit (Euro clearing, for instance) are also important. These threads add to the loss of profitability of big banks, partly due to new fintech and challenger banks, but also due to legacy problems from the crisis.”

Professor Hugh Willmott, Cass Business School and Dr Robin Klimecki, University of Bristol are the co-authors of a paper on Northern Rock From Demutualisation to Meltdown: A Tale of Two Wannabe Banks. They consider issues around remutualisation and consumer debt.

Remutualisation

“After nationalisation, Northern Rock was split into a ‘good bank’ and a ‘bad bank’. The former, Northern Rock plc, was sold to Virgin Money in 2011 while the latter, NRAM plc, was acquired by the American private equity firm Cerberus Capital Management in 2016.

“Resulting in a (moderate) profit for the taxpayer, one cannot help but regard the story of Northern Rock’s nationalisation as a wasted opportunity. Remutualising the former building society could have provided for more diversity and choice as well as, in the words of Chuka Umunna, ‘a valuable dose of participatory democracy in the financial sector'.”

Consumer Debt

“Northern Rock relied heavily on wholesale market borrowing to fund its aggressive expansion. 10 years after its nationalisation, UK lenders are arguably ‘safer’. They are better capitalised, less reliant on wholesale funding, and regulation has helped to curb some of the more excessive banking practices that characterised the lead-up to the financial crisis.

“But private debt remains a major issue. Some of the excessive practices appear to have resurfaced in the consumer credit markets. After warnings by the Bank of England, there have been some efforts to clamp down on consumer credit expansion in recent months.

“Nonetheless, household unsecured debt still stands at a total of over £200bn and continues to rise with austerity and the inflation-related decline in the purchasing power of wages.”

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