Systemic Failure Archive and Research

Northern Rock (UK, September 2007)

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Summary

On 14 September 2007 Northern Rock, a mortgage lender that had grown fast by borrowing in wholesale markets rather than relying on savers’ deposits, suffered the first run on a British bank since the Victorian era. When wholesale funding markets froze in the summer of 2007, the bank — which drew around three-quarters of its funding from those markets — could not refinance itself and turned to the Bank of England for emergency support. News of that support triggered queues of depositors outside its branches. The bank was nationalised on 22 February 2008. It was an early tremor of the global financial crisis, and a study in a fragile business model meeting a fragmented regulator.

Systemic Features

  • A funding model coupled to markets that could vanish. Northern Rock’s growth depended on continuously refinancing itself in wholesale markets and through securitisation. That coupled its survival to the willingness of those markets to lend — a source with no buffer, which closed almost overnight when the credit crunch struck (see tight coupling). The model worked beautifully until the moment it did not.
  • A latent condition, triggered. The funding structure was a dormant vulnerability, invisible and even admired while markets were liquid. The 2007 credit crunch was the trigger that turned a celebrated growth strategy into insolvency — a latent condition waiting for its conditions (see latent conditions).
  • Regulatory fragmentation. Supervision was split across the tripartite system — the Bank of England, the Financial Services Authority and the Treasury — with no one owning the whole risk. The FSA, the Treasury Select Committee found, had focused on capital-adequacy compliance and was remiss on the funding-model risk; responsibility for the systemic danger fell between the three bodies (see organisations as cognitive systems).
  • The run as a reflexive feedback loop. A bank run is self-fulfilling: it is rational to withdraw if you expect others to. With no credible deposit guarantee to break the loop, depositors queuing was not panic but sound individual logic aggregating into collective catastrophe — a positive-feedback dynamic the same in shape as the panic buying in the 2000 fuel crisis.
  • Moral hazard versus contagion. The authorities hesitated to provide liquidity for fear of rewarding bad lending, then judged that letting the bank fail risked contagion to similar lenders — the same bind between local discipline and systemic protection that recurs in tightly-coupled systems.

Cascading Systems Affected

  • Depositors, savers and staff of the bank
  • The mortgage market and wider financial confidence (doubt spread from “upstart” lenders to the major banks within a year)
  • Public finances (emergency lending, then nationalisation)
  • The UK’s financial-regulatory architecture

Impacts

  • The run of 14 September 2007; nationalisation on 22 February 2008 after two failed private rescues.
  • The Treasury Select Committee concluded the FSA had not supervised Northern Rock properly, and the FSA’s own review admitted supervisory failings; the run exposed both the tripartite system and the inadequacy of depositor protection.
  • Reforms followed: a strengthened deposit guarantee, a Special Resolution Regime for failing banks (Banking Act 2009), and — in 2013 — the abolition of the tripartite arrangement and the FSA, replaced by the Prudential Regulation Authority and Financial Conduct Authority with a Financial Policy Committee at the Bank of England.
  • Northern Rock proved an early warning of the fragilities that produced the 2008 crisis.

Further Reading / Sources

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