Northern Rock: Risk Management

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  • Topic: Bank of England, Northern Rock, Bank run
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  • Published : May 11, 2011
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Northern Rock plc
Risk Management Home Assignment
Northern Rock plc
Risk Management Home Assignment

Authors:
Serghei Leahu
Alexandru Mangir
Mihail Mavrin

Seminar leader:
Herbert Windsor
Authors:
Serghei Leahu
Alexandru Mangir
Mihail Mavrin

Seminar leader:
Herbert Windsor

Table of Contents
Executive summary2
Economic and financial environment description3
Causes and circumstances of incurred losses5
Errors by the organisation8
Errors by internal and external supervising authorities10
The internal authorities10
The external authorities10
Effects on other commercial organisations12
Conclusions14
References15

Executive summary
According to the House of Common’s Treasury Committee’s Fifth Report of Session 2007-08 “The run on the Rock”, on the evening of Thursday 13 September 2007 at 8.30 PM the BBC announced that Northern Rock plc had asked for and received emergency financial support from the Bank of England. The terms of the funding facility were finalised in the early hours of Friday 14 September and announced at 7.00 AM that day. That day, long queues began to form outside some of Northern Rock’s branches; later, its website collapsed and its phone lines were reported to be jammed. The first bank run in the United Kingdom since Victorian times was underway. The purpose of this home assignment is to critically discuss the Northern Rock plc bank run from a faulty risk management perspective. We seek to examine what were the causes of the collapse of Britain’s fifth largest mortgage lender, associated consequences for both the bank and other financial institutions (both domestic and international), the way authorities coped with this event and possible lessons to be drawn about proper and improper risk management.

Economic and financial environment description
For a better understanding of the details of risk management problems that engulfed Northern Rock plc, it is of vital importance to first and foremost take a look at the financial environment during the period of the loss. Real GDP growth projections as of 4 April 2007

Country/Region| 2006| 2007| 2008|
United States| 3,25| 2,25| 2,5|
Western Europe| 2,75| 2,5| 2,25|
United Kingdom| 2,75| 2,75| 2,5|
Other West Europe| 3,75| 3| 2,75|
Euro area| 2,75| 2,5| 2|
Emerging markets| 7,25| 6,5| 6,25|
World(WEO weights)| 5,25| 4,25| 4,25|

In August of 2007, the UK found itself affected by global financial chaos. Citing bank Credit Europe (2007), the liquidity crisis originated from the US subprime mortgage market. In mainland Europe, the crisis is believed to have been triggered when French based bank BNP Paribas suspended three of its investment funds that were exposed to the US markets that traded 'toxic' assets, as reported by BBC News on 9 August 2007. As a result, share prices plummeted and banks would not continue lending to each other. So, all major central banks around the world started injecting liquidity into their domestic markets in similar attempts. The European Central Bank sought to calm the tide by reportedly pumping $130 billion in the European banking system. It sought to satisfy Eurozone liquidity demands as fast as possible, unlike the Bank of England who left UK banks' claims for liquidity unsettled. The Bank of England did not follow suit and took no contingency measures in order to protect against moral hazard. Their rationalisation was that an injection would induce banks to take on more liquidity risk, resting sound knowing that the Bank of England would find a way to save them.

Injecting money into economy to prevent crisis have two major risks, first one is slowing growth too much in case of trying to avoid issuing new money, and second one is that inflation pressures will rise in case of issuing too much , at the end even with a greater slowdown. Due to these risks, the bank of England did not inject money into the UK financial...
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