Northern Rock has really put its shareholders through it this month. And its customers, for that matter. Having applied for an emergency Bank of England loan at an extortionate rate (the last resort for banks) the mortgage lender sent a clear message out to the world: our business model is flawed: danger ahead!
Why? Because Northern Rock relies on the global credit markets to run its business. Only a small portion of its customers’ savings support its mortgage lending function. So when the horrors of the subprime crisis began to unfold this year, interbank lending started to dry up. And Northern Rock had nowhere to turn for a credit injection.
The Credit Crunch
The fact that high street banks are scared to lend money to each other is a big deal. These are global, multi-billion pound organisations with pretty good day-to-day cash flow. But once their subprime exposure becomes clear, many leading institutions could have a lot of new debt on their hands. They just can’t afford to be lending to others right now – least not with other providers who can’t pay it off on demand.
The Best Bank Accounts During The Credit Crunch
Can anything be learned from the Northern Rock crisis? Under the Financial Services Compensation Scheme, banks only have to guarantee 90% of their customer savings up to £33,000. Anything over that could be lost forever, should the bank get into real trouble. Therefore, one way to cut personal exposure is to split out large funds between different banks.
Putting money under the mattress is definitely not a good idea, though tempting after Northern Rock's massive letdown. Lucky, perhaps, that the Government came to its rescue – but not before £2 billion of savings had been withdrawn – to guarantee customers their money. But ultimately, the Government can’t back all banks and their customer savings, so if the subprime exposure of some banks turns out to be significant, it is the savers – not the spenders – who will pay.
Northern Rock Shareholders
Meanwhile, Northern Rock's shareholders have lost 70% of their investment over the last month alone. This includes its directors who were blissfully buying up shares over the summer months. Astonishingly, it seems not even the insiders were aware of the potential impact of a credit crunch on the mortgage business.
Analysts have been warning of the impending credit crunch for long time now. There is a hideous amount of debt in the global financial system, created by slack rules and regulations, specifically among US subprime mortgage providers. The current media hype around the subprime crisis stems from mortgage lenders in the US giving huge house loans to people with poor credit histories. Now, with a high number of defaults emerging, the impact is being seen across the sector, often with oblivious end-parties paying the price.
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