The Northern Rock Banking Crisis

This assignment examines the collapse of Northern Rock bank, a significant event in recent financial history. It delves into the bank's core problems, including its reliance on securitization and liquidity issues, ultimately leading to its failure. The essay analyzes the broader economic consequences of this crisis, highlighting the ripple effects felt throughout the global financial system.

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TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
DESCRIPTION ABOUT THE BANKS AND FINANCIAL CRISES...........................................1
MARKET FAILURE AND BEHAVIOURAL BIAS.....................................................................4
RECOMMENDATIONS.................................................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................8

ILLUSTRATION INDEX
Illustration 1: Northern Rock...........................................................................................................2
Illustration 2: Various businesses at Northern Rock........................................................................3
Illustration 3: Change in Demand and Supply of Money................................................................4
Illustration 4: Effect of Financial Crises..........................................................................................5
Illustration 5: Amount of Loan provided by Banks.........................................................................6

INTRODUCTION
Essay incorporates impact of financial crisis over the UK economy and its wider impact
on Northern Rock which demands aid from the bank of England to meet its liquidity needs. The
aim behind this essay is to understand impact of financial crisis on banks and reaching to a
conclusion to what banks should undertake to restructure and reposition itself. The impact of
financial crisis has affected Northern Rock in the UK as well as Lehman Brothers in New York
who faced huge losses and ultimately collapsed.
DESCRIPTION ABOUT THE BANKS AND FINANCIAL CRISES
Bank failures are common and occur mostly in every region or country due to certain
imbalances (Dewandaru, Masih and Masih, 2018). However, the cost associated with the
collapse of banks is huge which might affect economic growth and stability. At times, reserve
banks and government intervene to provide help to banks in order to rescue them from
insolvency. Failure of banks impacts its stakeholders and brings in multiple consequences for
others as well. One of the essential consequence is that the depositors are unaware of the stability
or failure of banks. Northern Rock was the one of the biggest casualty of the global financial
crisis that occurred between 2007 and 2009 (Katie, 2013). During this period, the bank faced
liquidity problems, and was forced to borrow from the Central Bank of England to resolve its
liquidity issues. Another major problem of the global crisis were the bankruptcy of Lehman
brothers which marked the history of bank Failure. The global financial market broke down with
the downturn of the fourth largest bank of America.
Northern Rock started its operations in 1997 having 75 branches serving billions of
people in UK has stopped its operations in 2012. The major issue faced by Northern bank is
retailers and customers withdrawing money from the bank which collapsed its normal working.
The company aims at providing mortgage facilities to customers and retailers all over UK so as
to grow and make profit with loan income (Katie, 2013). Though the organization faced a huge
loss during the 2007-2008 financial crisis, as it was unable to generate ample income to perform
its daily operations. The bank thus, asked the government to intervene and has faced a downturn
being impacted by the bank run. The bank went public in 2008 as the government aided the bank
providing billions of amount to function which was an alternative from becoming insolvent. The
asset management company was later acquire by the Virgin Group and is known as Virgin
Money engaged in the process of securitization (Rockoff and Suto, 2018).
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(Source: Rockoff and Suto, 2018)
All these investment banks were engaged in mortgage business, retail savings and selling
insurance products thereby receiving deposits and lending loans to big retailers and customers
(Berger and Bouwman, 2017). Several theories as well as market research has been conducted to
evaluate the failure of major banks which brought economic instability in the UK. As investment
banks, they have provided huge credits to corporate borrowers and retailers with high interest
rate but these borrowed loans will be received at a stipulated time only by the bank and not
before (Dagher, 2018). In a case of prolonged credit crunch, borrowers are not able to repay the
borrowed amount which force banks to become insolvent as they are not able to meet their daily
transactions.
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Illustration 1: Northern Rock

(Source: Dewandaru, Masih and Masih, 2018)
Both the banks has a competitive strategy to make money thereby selling loans with
higher interest rates to corporates and retailers with a longer time period (Dewandaru, Masih and
Masih, 2018). The major loss faced by Northern Rock was due to wholesale and retail depositors
withdrew their savings. A boom in the country has impacted both the banks to become insolvent
as they are engaged in securitization process which involves converting illiquid assets into liquid
securities by combining them into asset backed securities. These securities is then sold to either
third party or investors and thereby, making profit (Rockoff and Suto, 2018). Thus securitization
posed a negative effect on the banks as they borrowed for short term and lends for a longer time
period which will recover only at a stipulated time making the banks run out of liquidity
(Castells and et.al., 2018). This has enhanced their financial risk and thus brought in global
financial crisis for the economies which has increased inflation.
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Illustration 2: Various businesses at Northern Rock

(Sources: How Biases Affect Investor Behaviour, 2014)
MARKET FAILURE AND BEHAVIOURAL BIAS
Northern Rock has seen a tragic market failure at the time of great recession which
created an imbalance between the quantity demanded and quantity supplied with rise in interest
rate (Berger and Bouwman, 2017). With increase in rate of mortgage housing prices increased
tremendously making people homeless and led to a rapid devaluation of financial instruments.
Since Northern rock was engaged in securitization process it has affected badly by the financial
crisis of 2008. Some banks separated investment banking from commercial banking, which was
known as the comprehensive thrift and bank fraud prosecution.
Investor behaviour often deviates from logic and reason, and investors display many
behaviour biases that influence their investment decision-making processes (Rockoff and Suto,
2018). Investing involves behaviour of individual while buying or selling securities. The
financial crisis came into existence due to deregulations in the financial industry which impacted
many banks including Northern rock which has to be declared bankrupt later on. The reasons of
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Illustration 3: Change in Demand and Supply of Money

financial crisis shows the banks created too much money by providing loans Dewandaru, Masih
and Masih, 2018). This has created a double effect as money was multiplied with creation of
debt. The money provided as loans was mostly used as a source of house funding which
tremendously increased house prices. The market efficiency which refers to as the investor’s
knowledge about the stock prices prevailing in market has affected decision making. The
behavioural biases of investors at times affect decision making which is another reason of
financial crisis and its impact on the banking sector (Castells and et.al., 2018). The major failure
of Northern Rock point towards explicit availability of loans which created speculation
opportunity thereby draining economies where debt payment by people was not possible. This
has led many banks including Northern Rock and Lehman Brothers to file for bankruptcy
(Berger and Bouwman, 2017).
(Sources: How Biases Affect Investor Behaviour, 2014.)
RECOMMENDATIONS
It would have been vital for all the banks to check on a regular basis the amount of loan
being supplied and the income generated (Wolfson, 2017). Such a specific criteria may help
them pass the financial crisis more easily thereby maintaining their normal business. The above
discussion proved that huge amount of loans has led to the failure of two major banks which
could have survived if the loans have been regulated (Berger and Bouwman, 2017). The Bank of
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Illustration 4: Effect of Financial Crises

England needs to come at rescue for the Northern rock which became bankrupt. After the crisis
or credit crunch, banks reduced loans in order to shrink economy so prices in markets drop to
normal giving purchasing power to consumer of necessity goods. The banks should have
maintained ample amount of liquidity so as to meet needs of daily basis (Berger and Bouwman,
2017). The reason behind failure of Northern Rock and Lehman Brothers was low cash reserves
which forces customers to withdraw their money. Tax policy has a significant impact on the cost
and flow of capital as they reduce speculation activities (Wolfson, 2017).
(Source: How Biases Affect Investor Behaviour, 2014)
It was thus clearly recommended to keep a check on the amounts coming in and going
out so as to maintain balance helping growth of banks in a proper way (Muir, 2017). The
Northern Rock and Lehman Brothers failed due to the biases nature of investors and irregular
activities including speculation (Bookstaber, 2017).
CONCLUSION
Essay depicts the reason behind banks failure and various associated causes which
impacted whole economy. Failure of Northern Rock has brought a downturn in economy as it
was the oldest banking people. It all started after the bank was unable to meet its daily
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Illustration 5: Amount of Loan provided by Banks

requirement of cash which needs to involve The Bank of England for funding. The interruption
by BOE has affected its image forcing people to withdraw their amount making bank illiquid.
This has in turn affected the bank's share price which reduced to 31%. Essay also provides light
on process of securitization which is the major reason behind bank failure as bank was not able
to generate income with regard to the loans given.
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REFERENCES
Books and Journals
Berger, A. N. and Bouwman, C. H., 2017. Bank liquidity creation, monetary policy, and
financial crisis. Journal of Financial Stability. 30. pp.139-155.
Bookstaber, R., 2017. The End of Theory: Financial Crisis, the Failure of Economics, and the
Sweep of Human Interaction. Princeton University Press.
Castells, M. and et.al., 2018. Europe's crisis. John Wiley & Sons.
Dagher, J., 2018. Regulatory Cycles: Revisiting the Political Economy of Financial Crisis.
International Monetary Fund.
Dewandaru, G., Masih, R. and Masih, M., 2018. Unraveling the Financial Contagion in
European Stock Markets During Financial Crisis: Multi-Timescale Analysis. Emerging
Markets Finance and Trade. 54(4). pp.859-880.
Katie. J., 2013. Why Banks Fail: A Case Study of Northern Rock, Lehman brothers, and Union
Bank of Switzerland (UBS)?. Paperback.
Muir, T., 2017. Financial crisis and risk premia. The Quarterly Journal of Economics. 132(2).
pp.765-809.
Rockoff, H. and Suto, I., 2018. Coping with Financial Crisis. Springer.
Wolfson, M. H., 2017. Financial crisis: Understanding the postwar US experience. Routledge.
Online
How Biases Affect Investor Behaviour. 2014. [Online]. Available through:
<http://www.europeanfinancialreview.com/?p=512>
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