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Northern Rock About To Call On The Money

It was only a week ago that Northern Rock got the nod from the Bank of England (BoE) that the latter would act as lender of last resort to the bank. Now it looks like Northern Rock will actually have to call on the emergency money in the next few days.

Cash is drying up as a combination of huge withdrawals by panicking customers and the inability of the bank to rollover short term debt in the money markets takes its toll on cash resources. The loan from the BoE will of course carry interest.

As the BoE prepares to lend to Northern Rock, the former has also injected another £4.4bn into the banking system in an attempt to bring down the rate at which banks lend money to each other. This was, said the BoE, an ‘exceptional’ new intervention in the money markets, as lenders are still refusing to stump up cash to fellow financial institutions.

It is the second chunk of £4.4bn, following on from the same amount lent last week, and came as the BoE said that banks had become even more desperate for cash as the Northern Rock crisis continued to deepen.

The inter-bank lending rate (Libor) went down as a result, but at 6.14%, was still higher than the BoE base rate of 5.75%.

News that Northern Rock will have to call on its loan so soon will do little to help the perilous state of financial markets. Crisis meetings have been held between Chancellor Alistair Darling, FSA chief executive Hector Sants and BoE governor Mervyn King, and on Thursday Mr King was called upon to answer questions about the Bank’s handling of the crisis by the Treasury Select Committee. The Bank has been accused of weaving a number of U-turns. King said he would not rescue ‘unwise’ lenders, but the Bank has bailed out Northern Rock.

It seems that events are moving faster than the authorities and institutions can keep up with. The BoE seemed prepared to ride out the crisis for a period, but as things got worse it as forced to act. Its actions now seem to have been too little, and they have had to take further action.

Meanwhile foreign central banks have acted faster and gained praise for it. The Federal Reserve in the US and the European Central Bank reacted quicker to problems with more decisive actions.

The government added to Northern Rock’s woes when it said that it would not guarantee savings in new accounts opened after midnight on Wednesday 19 September. The Treasury said its guarantee on deposits, interest payments and movement of funds would only apply to accounts existing at midnight. That makes the likelihood of cash coming in from new savers virtually zero. The bank’s shares fell as a result.

Guarantees are in place for existing savers and for savers who have withdrawn, but re-open their account. Up to 75,000 of Northern Rock’s 1.5m accounts have been closed in the past week.

The best bet for the stricken bank would now appear to be a takeover, but there aren’t many candidates in the current climate.

Tom Smith
27th September 2007

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