Lessons from the Northern Rock Episode [chapter]

David G. Mayes, Geoffrey Wood
2009 Financial Institutions and Markets  
We consider the lessons that might be learned by other countries from the problems with Northern Rock and the reactions of the UK authorities. We ask whether the surprise of the run on the bank came because economic analysis did not provide the right guidance or whether it was simply a problem of practical implementation. We conclude it was the latter and that as a result other countries will want to review the detail of their deposit insurance and their regimes for handling banking problems
more » ... insolvency. The relationships between the various authorities involved were shown to be crucial; were a similar problem to occur in a cross-border institution the difficulties experienced in the UK could be small by comparison. JEL: G28, E53, G21 key words: Northern Rock, bank failure, bank run, deposit insurance, lender of last resort Up to September of 2007, the authorities in the UK, and most private sector observers there, thought that the idea of a bank run on a solvent bank, with pictures of distressed depositors queuing in the street, was something that occurred in other parts of the world, such as South America, and not something that could happen at home. After all it had been nearly 150 years since the last significant bank run (on Overend, Gurney, and Co. in 1866) and the London market, particularly through Bagehot, had developed the ideas ,which most other financial centres have followed, of an effective Lender of Last Resort to help banks which are illiquid but can offer adequate collateral. The UK was much slower to adopt deposit insurance, a device intended among other purposes to prevent bank runs, but such arrangements were in place and were more generous than in much of the rest of the European Union, as prescribed under EU law. Thus, according to the ideas of Diamond and Dybvig (1983), depositors should not have felt any need to rush for their money when a bank seemed to be in difficulty -they were protected, and by more than one means. This article deals with the experience from the run on Northern Rock, a substantial and venerable depository institution, which in theory should never have occurred. We do not document the crisis itself as this has been done in House of Commons (2008) and an extensive article by Milne and Wood (2008), to which the reader can refer, but focus in the implications.
doi:10.1057/9780230103245_4 fatcat:fndzt5tivjevfclpi3om7ndorm