Bank of England and Northern Rock

The subprime mortgage problems emanating from the U.S. impacted the U.K. economy in a high-profile manner in the fall of 2007. The Northern Rock Bank had invested heavily in Collateralized Debt Obligation (CDOs) instruments containing high percentages of questionable mortgages issued by U.S. lenders. As the number of mortgage defaults grew and the recognition of the scope of the problem became known, holders of these CDOs were finding it increasingly difficult to sell their stakes in the securities.

Northern Rock Bank Liquidity Problems

Financial institutions that faced exposure to the subprime market began hoarding cash to ensure they could meet their obligations, making the pool of funds that banks routinely lend to each other essentially unavailable. The Northern Rock Bank – unable to sell their holdings in sub-prime CDOs or borrow money from other sources – found itself in a position whereby it risked meeting its deposit demand obligations.

In the U.S., Federal Reserve Chairman Ben Bernanke supported an open-market approach that would allow the markets to find its equilibrium. However, the Federal Reserve did dramatically increase funds available for short-term lending to provide capital to the financial system. The European Central Bank also greatly increased funds to ensure sufficient liquidity.[1]

Initially, King seemed reluctant to make similar policy changes to address the shortages in available credit facing the U.K. He also ruled out any direct intervention to provide funds to individual institutions. King publically stated that offering emergency relief would only make it possible for institutions that had acted irresponsibly through neglect or recklessness to continue such behavior.[2] The Bank did agree to offer additional loans to institutions requiring loans on an overnight basis, but these loans would be charged at a higher interest rate than the prevalent lending rate, and this only came about after several weeks of public commentaries between King and the heads of several of the nation’s largest banks.

Questions Over How Bank of England Handled Crisis

Of course, the media reported on all this which only served to increase the general public’s anxiety to the point that when Barclays – one of the strongest and most secure banks in Britain – asked for a £1.6 billion overnight loan, it was reported in many headlines that Barclays was in danger of going under. Even though such a loan request was not exceptional by any means, it was interpreted by the public as a sign that the entire financial system was in crisis. This was the opposite effect that the Bank of England wanted and it was only after realizing that the wrong message was being sent out by the Bank’s actions that the penalty rate on overnight loans was removed and more money was released.

By this time however, the perception was that King and the Bank of England had mishandled the credit crisis and King’s abilities to lead the Bank was called into question. Comments like, “You cannot calibrate liquidity to only rescue the deserving” and that he did not support propping up the “greedy and egregious” did very little to calm anxious investors across the country.[3] King’s judgment was further questioned in the face of the hundreds of billions of dollars and euros that the Federal Reserve and the European Central Bank were flooding into the market, while the Bank of England authorized only £4.4 billion.

Meanwhile, U.K. bank share prices began to fall, but the real catalyst was news coming from the Northern Rock Bank that it could not secure enough cash to meet its demand deposit obligations. This news, together with an eroding confidence in the health of the financial system, led to long lineups of individuals withdrawing their savings from Northern Rock branches. Finally, the Bank of England – pressured by the Financial Services Authority (FSA) – provided emergency funds to the Northern Rock to calm the jittery nerves of savers with Northern Rock.

If there is a lesson in all this, it is quite simply that the Bank of England, like any central bank, has a responsibility to provide guidance and to be aware of the important role it plays in ensuring confidence in the financial system of its country. The Northern Rock issue was not a question of solvency as there was no immediate danger of bankruptcy. No danger that is, until the public believed that a relatively straight-forward liquidity problem was actually something more significant. Without clear communication from its central bank, the public assumed the worst and acted to protect itself as best it could.

Update – January 30, 2008

The HM Treasury announced earlier today that Mervyn King has been re-appointed to a five-year term as the Governor of the Bank of England. The Queen has officially approved the continuation of King’s mandate which will commence once his current term ends on June 30 of this year. This also means that King will continue to serve as Chair of the Monetary Policy Committee.

Related Links

Bank of England
Governor Mervyn King
Bank of England website


  1. ↑ BBC News Online – November 8, 2007
  2. ↑ The Daily Mail – September 17, 2007
  3. ↑ The Daily Mail – September 17, 2007

About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.

This article is for general information purposes only. It is not investment advice or a solicitation to buy or sell securities. Opinions are the author’s — not necessarily OANDA’s, its officers or directors. OANDA’s Terms of Use apply.