Northern Rock Crisis Essay

1. INTRODUCTION

Northern Rock was founded in 1965 by merger of Northern Counties Permanent Building Society and Rock building Society based in Newcastle. In the beginning, Northern Rock acquired 53 smaller financial institutions. Initially Northern rock was a building society it means it was a mutual organization until 1997, when it entered the stock exchange market. Then in 2000, it was upheld to FTSE 100 index of top 100 highly capitalized companies listed in London Stock Exchange. From 1997-2007, the assets of Northern Rock grew 20% every year and before the crisis on 14th September 2007, it was 5th biggest UK bank based on its mortgage assets. The business model of Northern Rock heavily depended on wholesale markets as alternative to retail

So, it was able to generate money at cheaper price than its competitors in UK giving it a competitive edge as Northern Rock could place a lower price on its mortgages and thus, greatly expanded in the mortgage market. However, the bad side of this scenario was when the markets were no liquid anymore and the bank faced problem in generating funds. The assets started falling because initial investors failed to refund investments and the situation of bank run arose which caused the failure of Northern Rock (Huijbregts, 2007). This crisis was a small pivot on which political and economy fortunes turned. Bank run is a situation when depositors start withdrawal of money on large amounts because of the fear that the bank will fail. The bank was nationalized on 22 February 2008 after two unsuccessful offers to assume control over the bank, nor having the capacity to completely focus on reimbursement of taxpayer's cash. Government adequately removed responsibility for indebted foundation from its investors, without repayment. The bank was split in assets and banking on January 2010 and after one year in June 2011, the bank was put up for sale to private sector. On 17 November 2011, Virgin Money bought the Northern Rock

Although the Treasury was aware of its shortcomings in this field, yet it was working with the Financial Services Authority and the Bank of England to overcome its weaknesses. Subsequent to nationalization, the fresh management of Northern Rock found that they had exploited arrears on the mortgage book earlier than other lenders. So the performance of the bank looked better than the reality. Company’s auditors had mistakenly missed these understatements before. Also, the bidders did not realize these understatements and when in May 2008, the capitalizing policy was changed, there was a significant increase in the reported rate of arrears. And the Treasury admitted that the bank’s arrears were higher than industry. In April 2009, Northern Rock residential mortgages in arrears had increased from 2.92% to 3.67%. In short, the Treasury was successful to meet its objective of protecting the depositors of Northern Rock and reduce the bank run issue (House of Commons: Public Accounts Committee,