Nobody alive in Britain in 2007 had ever seen a bank run: the last time depositors all tried to withdraw their money at the same time in the UK came in 1878.
Yet a decade ago this week British depositors rushed to withdraw what funds they could from the stricken Northern Rock, with queues around street corners at Newcastle branches providing one of the defining images of the financial crisis.
Ten years on and the British banking sector is in many ways unrecognisable. High street banks have faced a tumultuous decade, and much of that change can be traced back directly to 14 September 2007, when the UK faced its first taste of real financial panic in decades.
The first run in a century
Newcastle-headquartered Northern Rock was the fifth largest mortgage lender in the UK at the time and an economic flag-carrier for the north eastern economy, a superficially unlikely candidate for a bank run. However, the supposedly safe as houses UK banking sector had become exposed to financial conditions around the world.
The trouble had started across the Atlantic, where the securitisation process was invented. Banks made massive profits from the process: banks made loans, packaged them together into securities – bonds – which then paid regular coupon returns to investors. The banks could then sell them on, and rake in fees.
That model was followed by Northern Rock. Yet one of the painful ironies of Northern Rock’s fall is that it was not bad loans which caused its downfall, but rather the subsequent rush by investors around the world to pull back their money.
The run started in earnest on Friday 14 September, when the Bank of England announced it would provide liquidity support to Northern Rock. The Bank said Northern Rock was solvent – and, indeed, it was by most accounts – yet it fell victim to a startling fall in confidence after the BBC reported it was struggling for cash.
Liquidity crunch time
A wave of defaults in the now-infamous US subprime mortgage market had exposed the securities (rated ridiculously highly) as far more risky than previously thought, causing panic on the money markets in which Northern Rock borrowed money. Northern Rock was also heavily involved in securitisation, but its problems did not come from borrowers defaulting on dodgy loans.
Instead, their business model relied on a constant supply of debt, which was then used to fund new loans. Only 22.4 per cent of its liabilities were funded by retail deposits in 2006, according to the Treasury Select Committee’s report, leaving it far more exposed than other banks when the other source of funding dried up.
“In order for the model to work, you need to be originating and getting the capital back,” says Darren Ruane, head of fixed interest at Investec.
When complacent investors suddenly realised they were caught short in the US, money markets dried up and there was no cash available to fund Northern Rock’s own loan repayments. There is no doubt the bank was in trouble, as were all major British lenders, but it may well have carried on functioning had the run not started, according to Rob Ford, a former Barclays banker and founding partner at TwentyFour Asset Management, which still invests in bonds backed by mortgages originated by Northern Rock.
“It was perfectly able to fund itself at that point in time,” he says, although “it might not have been able to a year later” when Lehman Brothers collapsed.
Could it happen again?
After a decade, endless inquiries and years of weak growth, the banking system has changed, to the point that the strategy pursued by Northern Rock has been banished from all but small, specialist lenders.
“Business models are policed much more closely now,” says Ruane.
The Bank of England has far stronger oversight, with macroprudential powers which the Financial Policy Committee can use to force banks to up their requirements for loans. Recent examples include making banks raise countercyclical capital buffers for a rainy day, or limiting lending at loan-to-income multiples of 4.5 and above.
“Mortgage lending standards have changed out of all proportion,” says Ford. “What happened specifically with Northern Rock in a number of ways can never happen again,” he adds, with all the caution that has been embedded in the psyche of a generation of investors.
There has also been widespread cultural change. A month after Northern Rock, the Economist magazine bemoaned the muddied reputation of an “admired regulatory system”. But so-called light-touch regulation has fallen out of fashion.
“People felt, ‘well, the banks know what they’re doing’”, says Ruane. “That culture is not there any more.”
The bad bank lives on
Northern Rock still lives on in one regard, with NRAM, the “bad bank” still administering mortgages. Indeed, NRAM is set to make an overall profit for the government. The sale of the loans (mainly mortgages) has netted the government billions, making up for the money pumped in during the crisis.
That is little consolation for those who lost thousands of pounds when the bank went under. Dennis Grainger now leads a group of as many as 150,000 pensioners and investors, mainly in the North East, who had their shares wiped out as trust in the bank proved horribly misguided.
“Do you feel you can sleep in your beds if you’re getting all this money from the bad bank?” Grainger says, addressing the Treasury.
Having exhausted their legal options, the shareholders’ only option left for any recompense is political pressure to push the government on a “compassionate” basis into giving them something from the profits it has made.
Government figures including ex-chancellor George Osborne have previously described the sale of Northern Rock’s loans as a welcome sign of the confidence in the UK economy – a symbol that the bad days of the crisis are a thing of the past.
Others are not so sure. Chief among those is Grainger.
“It’s had a real, major impact on the North East,” he says. “It knocked the credibility of Britain being clever with its banking and finance.”