Northern Rock Produced Britain's First Bank Run in 140 Years
Queues formed outside branches in September 2007 at a lender that had funded itself in wholesale markets rather than with deposits. The images were the first visible sign of the crisis in Britain.
The Model
Northern Rock had grown rapidly into a major British mortgage lender. Its funding model was the distinguishing feature. Rather than funding mortgages principally with retail deposits, it borrowed in wholesale markets and packaged mortgages into securities sold to investors.
The approach had genuine advantages. Wholesale funding could be raised quickly in large quantities, which permitted growth far faster than gathering deposits branch by branch. It was also cheaper during normal conditions.
The Vulnerability
The weakness is the same one that has appeared in every case of this kind. Wholesale funding is provided by professional institutions that continuously assess credit, and it can be withdrawn quickly and without sentiment.
Retail depositors are comparatively inert. They rarely move accounts, are often covered by insurance, and are slow to react. A bank funded by deposits has a stable base. A bank funded by wholesale markets has a base that reprices daily and can disappear.
Wholesale funding is cheap because it is uncommitted. The discount is compensation for the fact that it can leave.
What Happened
As losses on American subprime mortgages emerged during 2007, wholesale funding markets tightened sharply. Institutions became unwilling to lend to counterparties whose exposures they could not assess, and securitization markets effectively closed.
Northern Rock's assets were predominantly British residential mortgages, which were performing reasonably. The problem was not asset quality but the inability to refinance.
The bank approached the Bank of England for emergency support. When that became public, retail depositors queued outside branches to withdraw funds, producing images that had not been seen in Britain since the nineteenth century.
The Irony of the Run
The retail run was the most visible element and the least important cause. The wholesale funding had already gone. Retail depositors were reacting to news of a support facility that had been necessary because professional lenders had withdrawn weeks earlier.
The government eventually guaranteed deposits to halt the run, and the bank was taken into public ownership in early 2008.
What It Changed
The episode exposed weaknesses in the British regulatory arrangement, where responsibilities were divided among three bodies, and the resulting reform consolidated prudential supervision within the Bank of England.
Deposit insurance was also strengthened. The prior scheme provided incomplete coverage above a low threshold, which gave depositors a rational reason to run. Coverage was increased and made complete up to the limit.
Internationally, the case contributed directly to liquidity requirements in subsequent regulation, which oblige banks to hold liquid assets against short term funding outflows and to limit reliance on unstable wholesale funding.
The Bottom Line
Northern Rock failed because its funding could leave faster than its mortgages could be sold, and the famous queues were a symptom rather than a cause. Cheap uncommitted funding is a bet that markets stay open.