Analysis of Difficulties and Conflicts
about Northern Rock Affair
1. Development Background
2. Reasons of failure in Northern Rock
3. Strategy for rescue of Northern Rock
4. Results of rescue of Northern Rock
4.1 Bank of England
4.2 Failure in supervisory authorities
4.3 Proposals for UK reforms
As Britain’s fifth largest mortgage bank, Northern Rock faced funding and management difficulties which is led by increased pressure among banks to sell, pushed down prices, and impacted the market for interbank loans due to the global market liquidity squeeze for securities happened in 2007. Hence, Northern Rock’s difficulties arose on account of its inability to manage its credit risk and liquidity risk. This report will present an analysis relations between investment and commercial activities of Northern Rock and interest in bank operation strategies, rely on analyzing the problems about inability in managing its credit risk and liquidity risk. It will also outline its rescue and reforms by the UK Government and financial authorities towards the end of the same year and the beginning of 2008 such as tripartite regulatory system, Treasure, the Financial Services Authority (FSA) and BoE operates.
1. Development Background
Northern Rock described itself as a “specialised lender, whose core business is the provision of UK residential mortgages funded in both retail and wholesale markets”. Northern Rock’s assets increased by 20% plus or minus 5% for the last 17 years. (Treasury Committee Report 2008)
To sustain high grow in assets, it changes the structure of liabilities to originate loans or purchases them from specialized brokers adopting an “originate-to-distribute” model(appendix 1) of funding and transfers them to Special Purpose Vehicle and package into collateralized debt obligations to other investors, a process known as “securitisation”. Thus a new entity was called Granite, which was their securitisation vehicle. Besides, to meet funding needs, in 2004 Northern Rock turned to covered bonds as a new funding strategy by using Limited Liability Partnership to fund assets and transfer risks so as to be a more secure investment to investors. Hence, investment and commercial activities of Northern Rock would have good effects on and motivate more interest in bank operation strategies.
However, the conflict between commercial activities and interest in bank operation strategies existed since the difficulties happened in 2007. In 2006, there is a parallel decrease in ratio of retail deposits in its wholesales funding, resulting that total liability and equity, retail deposits and funds decreased from 62.7% in 1997 to 22.4% in 2006 (appendix 2). The pressure of squeeze in global market liquidity for securities in 2007 has increased among banks to sell, make prices drop, and impacted the market for interbank loans, leading to a funding gap at Northern Rock. (Annual Report, 2007)
FSA stated that the entity was functioning normally. The overall funding of NR was comprised of: 50% securitisation with an average life of 3 ½ years; 10% was covered bonds with an average life of about 7 years; 25% wholesale borrowings, from which half had a duration no longer than one year and the other half less than one year. While the wholesale funding of NR grew, there was no corresponding growth in its retail funding. Retail deposits and funds fell significantly comparing to other banks that were previously building societies: from 62.7% at end-1997 to 22.4% at end-2006. (Annual Report, 2007)
2. Reasons of failure in Northern...
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