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    Banking crisis: Northern Rock Bank

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    Banking Crisiss in the Global Economy

    Case survey of Northern Rock Bank


    The intent of this paper is to offer an appraisal of the planetary banking crisis in context of Northern Rock instance. The paper describes the context of fiscal market convulsion utilizing statistical tools to analyze the Northern Rock instance in footings of the research objectives. It examines the impact of worsening lodging monetary values on the Northern Rock returns. As Northern Rock is a mortgage bank, any splash in the lodging market is likely to impact the bank. The paper besides delves into the inquiry of whether it was possible to foretell the crisis and take preventative steps. In this context, the cardinal determination is that a closer supervising and monitoring along with market subject could hold made it possible to foretell the crisis and take specific and timely preventative steps. Finally, the paper considers the possible solutions to Northern Rock instance. The paper brings together some of the strands of the analysis and addresses several lessons that can be learned.

    Table of Contentss

    ChapterPage No.

    IAn Introduction to the Study……………………………………………1

    IILiterature Review……………………………………………………….3

    IIIResearch Design and Methodology…………………………………….6

    IVFindings and Analysis…………………………………………………..9

    VConclusions and Recommendations…………………………………..16


    Appendix 1: Major Banking Crisis Instances ………………………………………..18

    Appendix 2:Beginnings of Funding……………………………………………………….19

    Appendix 3:Northern Rock Share Prices……………………………………………19

    Appendix 4: Working Notes…………………………………………………………….19

    Mentions and Bibliography………………………………………………… … 22

    List of Tables

    Table 1: Datas on Northern Rock……………………………………………………….9

    Table 2: Datas on Housing Prices………………………………………………………9

    Table 3: Capital Adequacy Ratios for Northern Rock……………………………..11

    Table 4: State ofLiquid…………………………………………………………….12

    Table 5: Fiscal Statement Figures………………………………………………13

    I ) Introduction

    Recent old ages have witnessed a figure of bank failures across the universe. In an interesting survey, Capiro and Klingebiel ( 1997 ) place ‘112 systemic banking crisis in 93 states and 51 boundary line crisis in 46 states since the late seventiess. More than 130 out of 180 of the IMF states have therefore experienced crisis or serious banking problems.’ ( Refer Appendix 1 for a list of these crisis )

    A banking crisis can be defined as “an episode in which a important proportion of Bankss fail or their assets are exhausted(UniversityofCambridge, Feb 2008 ). Even single Bankss may trip a banking crisis. Englund ( 1999 ) describes banking crises as one-off events faced by single Bankss. For illustration, the failures of the Herstatt Bank in Germany or Barings Bank in the UK were stray events. However, most of the instances of banking crises that disrupt economic activity are systemic in nature, as against single bank failures. Caprio and Klingebiel ( 1996 ) specify a systemic banking crisis as “a instance where the net worth of the banking system is about or wholly exhausted as nonperforming loans use up most or all capital in the banking system.”However, single bank failures may take to a entire loss in the banking system and therefore trip a crisis state of affairs. A crisis consequences when persons and companies lose their assurance in the banking system or an single bank and they start retreating their sedimentations, that is, there is a bank tally. The loss in the assurance can be due to assorted grounds, premier being deficiency of liquidness. Gersbach and Wenzelburger ( 2003 ) province that banking crises occur when bank ( s ) fail to run into capital adequateness demands or are insolvent. Minimum capital demands strengthen the foundation of the planetary banking system and allow Bankss to vie on an equal capital footing. (Gram molecules and Terry, 1997) .

    It has besides been observed that most banking crises occur in developing states. Harmonizing to Kunt and Detragiache ( 1998 ) , out of 30 major banking crises from the early 1980s onwards most of them occurred in developing states. However, developed states are as prone to these crises as any other state. In the last two old ages two names that have dominated the planetary banking crisis scenario are that of Northern Rock in UK and a US investing bank Bear Stearns, America ‘s fifth-largest bank. In fact the Credit Crunch of 2007 can be declared as the biggest Bank Crisis of 2008 as it is a menace to the banks’ liquidness every bit good as solvency across the developed every bit good as developing states.


    In the present survey an effort has been made to analyze the issue of Global Banking Crisis in context of Northern Rock bank, a medium sized bank, organizing a portion of Northern Rock plc. The survey focuses on recent findings of economic research and makes usage of statistical tools to understand why banking crisis erupted in Northern Rock and whether the crisis could hold been prevented. In the concluding subdivision, the survey besides attempts to urge the possible solutions to the Northern Rock instance

    two ) Need for the survey

    Though much has been written on assorted facets of Northern Bank crisis, the fact remains that there are lessons to be learned. These lessons are of import as a banking crisis can hold long term deductions and can take to economic break. Such crises significantly impair the balance sheets of both the Bankss every bit good as the borrowers. It leads to cut down imparting due to a falling net worth. This in bend forces a decrease in investing and ingestion disbursement due to a reduced depositors’ assurance. The undermining of depositors’ assurance in the banking system may, in bend, lead to capital escapes. All these factors together render the banking system inefficient. Due to all these of import resources are diverted to less efficient utilizations. In short, banking crisis leads to mayhem. Furthermore, a bank in a crises needs to be bailed out before the state of affairs gets out of custodies. Bank bailouts involve high fis­cal costs and increase public debt and debt service demands. For illustration, cost of the nest eggs and loans crisis in the USA in the late eightiess has been estimated to over USD 150 billion which is more than the cumulative loss of all US Bankss during the Great Depression, even after seting for rising prices. ( Caprio et al, 1996 ) . Therefore, it is of import to analyze issues involved in the Northern Rock crisis such that preventative steps are taken to guarantee that history does non reiterate itself. Therefore, the demand of the survey.

    three ) Objectives of the Study

    The purpose of this paper is to analyze the banking crises utilizing Northern Rock as a instance survey. Northern Rock is known to hold been difficult hit by the worsening lodging market. The aim of the paper is hence to:

    • Analyze the extent to which the worsening lodging market contributes to Northern Rock’s crises
    • Analyse whether it was possible to foretell the Northern Rock crisis and place the grounds why the crisis was non prevented
    • Recommend possible solutions to the Northern Rock instance

    The paper is structured into five chapters. It begins with a background of the Northern Rock theoretical account and the beginnings of it breakability. It examines the bing literature to acquire a background to construct on. The cardinal portion of the paper focuses on the nucleus research inquiries of relation between worsening lodging monetary values and Northern Rock returns, predictability and therefore bar possibility of the crisis and suggestions to decide the instance of Northern Rock. The concluding chapter summarizes the findings of the survey and makes recommendations.


    I ) Northern Rock Crisis: A Background

    In August 2007, UK experienced its first bank tally since Overend and Gurney in 1866. Around 11 % of a moderate-sized bank, Northern Rock’s deposits amounting to about ?3 billion were withdrawn.

    Northern Rock started as a common edifice society and got the position of the bank merely in 1997. Though acquisition of ‘bank’ position opened it up to full scope of banking operations, it continued to concentrate on residential mortgage market. It adopted a securitisation and support scheme whereby it issued mortgage-backed securities and other capital market support. Northern Rock practised a really aggressive market portion enlargement policy. In the first six months of 2007, Northern Rock managed to hold 40 per centum of the addition in gross UK mortgage loaning and 20 per centum of the cyberspace. However, about 75 per centum of its support came from short-run adoption in the sweeping markets, chiefly through the issue of asset-backed securities. In other words, unlike many other Bankss, Northern Rock relied on short-run market support. Appendix 2 shows a well higher proportion of sweeping support ( at 62 % ) in the instance of Northern Rock ( 62 per cent ) as compared to other Bankss (Llewellyn, D.T. , 2008 ) .This exposed the bank to a low-probability-high-impact ( LPHI ) hazard. The bank became to a great extent dependent on short-run support in the money and capital markets. Before they could gain it, there was a large-scale shrinking of liquidness in the markets chiefly due to the turbulency caused due to sub-prime loaning in the US.

    In retrospective, the three chief causes in the concern theoretical account that could hold triggered off the crisis are:

    • Having a higher sweeping support compared to other Bankss
    • Having securitisation as an built-in portion of the concern scheme
    • Not taking out any signifier of liquidness insurance

    The Northern Rock episode needs to be set in the context of the planetary fiscal market turbulency experienced in 2007. On 14 August 2007 the Bank of England was alerted by Financial Services Authority ( FSA ) and the Treasury on the possible impact of the planetary recognition squeezing on Northern Rock’s concerns. This was followed by a series of events clearly bespeaking that it was impossible for the bank to go on as a traveling concern. To resuscitate the client assurance the authorities guaranteed all retail sedimentations and sweeping sedimentations and most of the unbarred debt. This put the entire exposure of the authorities to Northern Rock at approximately ?60bn. The Bank of England created the Liquidity Support Facility with the understanding of the FSA and the Treasury through which it has lent about ?25bn to Northern Rock, secured against Northern Rock’s assets chiefly premier mortgages. By the terminal of September, the bank cancelled the proposed interim dividend for 2007 and decided to cut 2,000 occupations and cut down its residential mortgage loaning by half.


    Within the same period there was a major diminution in the portion monetary values of the bank.Appendix 3shows the motion in the portion monetary value of Northern Rock over the period February 2007 to September January 2008. The portions were suspended throughout the period 31 October 2007 to January 2008 and the monetary value as at that clip stood at about 100p per portion.

    With the general growing in the figure of planetary banking crises, it is barely surprising that these have attracted considerable attending in recent old ages. There are a few surveies that can be related to the research inquiry and aims of the present survey.

    two ) Review of Literature

    In an effort to travel beyond general tendencies, surveies have focused on anything from an analysis of causes, lessons learnt to likely solutions. While some research has focused merely on the description of crisis, other work has sought to demo how these erupt, the harm they do and what could hold been done to forestall these.

    Assorted articles and surveies have been conducted to analyze the cause of Northern Bank crisis. This analysis was required particularly when certain fiscal experts were of the sentiment that the bank was working decently till early 2007 thereby connoting that certain events in early 2007 could hold triggered this crisis. One major event was the sub-prime crisis in the US. Harmonizing to a really recent survey by David T. Llewellyn ( 2008 ) the worsening lodging market ensuing from the US sub-prime loaning clearly had an inauspicious impact on Northern Rock and possibly to a certain extent contributed to it. The survey clearly states that “Two jobs emerged during the summer months of 2007 there was a generalized deficiency of assurance in a peculiar plus category ( mortgage bank securities ) associated in big portion with developments in the sub-prime mortgage ( SPM ) market in the USA, and uncertainties emerged about the viability of the Northern Rock concern theoretical account in particular.” Thus, there is a possibility that Northern Rock crisis could hold got triggered by the worsening lodging market.

    Even though at that place could hold been grounds beyond the control of the bank to forestall the crisis, some surveies besides clearly high spot that the Northern Rock crisis could hold been predicted and prevented. Harmonizing to Vincent Cable, an MP for Twickenham, “investors have been worried about Northern Rock for months. And despite claims that it has a solid book of mortgage assets the truth is that it has been runing at the riskier terminal of an progressively hazardous market, with loans that are a multiple of income manner in surplus of normal prudent levels”Many others are besides of the same sentiment. Certain surveies in the yesteryear have indicated that it is possible to foretell banking crisis and therefore command them. Economists such as Bell and Pain ( 2000 ) or Davis ( 1999 ) have identified certain factors or indexs or forms among banking crisis. Harmonizing to them if these indexs or forms are closely monitored one can foretell nearing crises. Davis specifically refers to the instance of East Asiatic crisis in the late ninetiess. Harmonizing to him East Asiatic crisis exhibited characteristics


    like “exposure to existent dazes such as export monetary value fluctuations and foreign currency exposures” , which were really similar to those exhibited by earlier crisis in Japan and Scandinavia. Some economic experts such as Honohan and Klingebiel ( 2000 ) have besides attempted to measure features or signals in the banking systems that increase the chance of a likely banking crisis. Harmonizing to them, the pre-crisis liquidness support extended to a bank by the authorities is the biggest forecaster of the extent of financial cost that can ensue one time the crisis happens. Similarly, Ian Pollock of BBC News ( 2008 ) clearly points out that Northern Rock could hold been prevented if Financial Services Authority ( FSA ) was more watchful.

    Each clip there is a banking crisis, rampant literature becomes available to supply solutions to such crisis. Northern Rock has non been an exclusion. Surveies have emphasised market subject, closer supervising and more ordinances as the cardinal solutions. Goodhart and D Schoemaker ( 1995 ) show that effectual steps of deciding banking jobs vary from state to state. With respect to the supervising, assorted surveies have raised the issue of whether cardinal bank should play the supervisory function. Harmonizing to David Llewellyn ( 2004 )“the cardinal solution to the crisis is the location of prudential supervising, and in peculiarly whether or non the cardinal bank is to be the prudential supervisor of Bankss and, if so, whether this should besides embrace all other fiscal institutions.”Assorted other surveies analyse the issue of supervising. These include Goodhart 1999 ; Carmichael et al. , 2004 ; Healey, 2001 ; Luna-Martinez and Rose, 2003 ; Masciandaro, 2003 Oosterloo and de Haan, 2003. These surveies focus on prudential supervisor of Bankss, how many bureaus should be there and whether they should be integrated or dispersed and what function should the cardinal bank drama. All these surveies agree that there can non be a individual supervising theoretical account suiting all states.

    Calomiris ( 1998 ) and Evanoff and Wall ( 2000 ) suggest doing subordinated debt mandatary as a good agencies of guaranting market subject. Compulsory low-level debt can train a bank as the cost of publishing new debt additions when the hazard profile of bank additions. Therefore, if a bank is required to publish low-level debt clip an once more, it will be forced to cut down its hazard. Another issue happening rampant treatment is that failed Bankss tend to acquire bailed out than are liquidated. Goodhart et Al ( 1995 ) conducted a study of 104 neglecting Bankss and found that 73 resulted in deliverance and merely 31 in settlement.

    Though much has been done, there is much range here for a great trade more research. There has been a mention to lodging market and its relationship to Northern Rock, there is a range to utilize statistical tools to place the relationship and besides understand statistically if it was possible to foretell the crisis.


    I ) Research Methods

    Both quantitative and qualitative research methods will be used to accomplish the aim of the survey. The research methodological analysis for each aim is highlighted below:

    Obejctive 1: Analyze the extent to which the worsening lodging market contributes to Northern Rock’s crises

    To understand how the mortgage crises affected Northern Rock, this survey will analyze the relationship between the returns on Northern Rock’s stock and the lodging monetary values over the period 2005 to 2007. This will be done utilizing arrested development analysis.

    Arrested development analysis surveies the relationship between two variables, the dependant and independent variable. In this instance the returns will be the dependent variable whereas the lodging monetary values will be the independent variable. This relationship can be stated mathematically as follows:

    Where is a step of the return on Northern Rock’s stock at clip T.

    is the return on Northen rock’s stock that is return on Northern Rock that does non depend on the motion of mortgage monetary values ;

    steps the sensitiveness of Northern Rock’s returns to motions in mortgage monetary values ; and

    is a random error term with average nothing and measures the fluctuations in Northern Rock’s returns which are due to other factors.

    Harmonizing to Myers and Brealey ( 2002 ) , the monetary value of a stock today can be written in footings of its old monetary value, expected return and dividend as follows:

    The return on the stock is hence given by ;



    To better understand whether the theoretical account histories for the variableness in the returns, it is necessary to cipher the R-Square ( Coefficient of finding ) .

    It can besides be expressed as:

    Where‘n’is the figure of observations

    Ten is lodging monetary values

    Yttriums are returns of Northern Rock

    If theis less than 50 % , it is an indicant that, the theoretical account does non account for the variableness in the returns, in which instance it is necessary to include other variables into the theoretical account. As a consequence, a market index, the FTSE100 index will be included in the arrested development theoretical account. The new theoretical account will now be written as follows:

    Where steps the sensitiveness of Northern Rock’s returns to the FTSE100 index and steps the returns to the FTSE 100 at clip T.

    However, it should be noted that the new theoretical account will merely be taken into history if lt 50 %

    Hypothesiss trials will be carried out on Northern Rock’s sensitiveness to Mortgage monetary values, or the sensitiveness to motions in the FTSE 100 index, as the instance may be. This will be done at a P-value of 5 % .

    Aims 2:Analyse whether it was possible to foretell the Northern Rock crisis and place the grounds why the crisis was non prevented

    To understand whether the banking crises could be predicted, the survey will analyze the motion of the capital adequateness ratio of Northern Rock over the five twelvemonth period 2003 to 2007. In add-on, the liquidness of Northern Rock will be studied over the last five old ages every bit good. The Altman Z-Score theoretical account will besides be applied to Northern Rock’s informations to see if there was a possibility of bankruptcy.


    Aims 3:Recommend possible solutions to the Northern Rock instance

    The paper will reason by supplying possible solutions to the banking crises.

    two ) Data Collection

    The informations related to Northern Rock is based on the Annual Reports of the Northern Rock plc for the period. Housing information is based on the lodging statistics provided by the UK authorities and accessed from

    three ) Potential Limitations of the Research Methods

    Though the survey uses tried and tested statistical tools for its analysis, the restrictions of the tools can non be ignored. Following restrictions need to be highlighted:

    • Arrested development analysis is based on a additive theoretical account, that is, when relationships between the independent variables and the dependant variable are about additive. It can non be said with certainty that there is a perfect additive relationship between lodging monetary values and returns of the bank.
    • The information that has been used is published informations. However, there can be inaccuracies in the informations which may render the analysis incorrect.
    • The period covered is excessively little to take all prejudice in the analysis
    • A utility of hypothesis testing may be restricted as it is non easy to be precise about the corresponding chance if the alternate hypothesis is true.
    • The Altman Z-score has assorted versions and cut-off points are defined consequently. A alteration in the version will alter the result.

    I ) Housing Market & A ; Northern Rock Returns

    Through arrested development analysis, a relationship has been established between the worsening lodging market and the returns of Northern Rock. Returns here imply returns to the equity stockholders.

    There was a 20.3 % addition in dividend per portion in 2006 over 2005. An interim dividend was announced in the first half of 2007 at 14.2p which was higher than the interim dividend in the old twelvemonth. It was due to be paid in the 2nd half of the twelvemonth. However, due excessively the ambitious conditions faced by the Company it was hence cancelled. No ordinary dividend was declared for 2007. Tax returns on Northern Rock (( Refer Annexure 4 ( a ) for computations )stock for the old ages 2005, 2006 and 2007 calculated on the footing of the dividend per portion and the current and old twelvemonth monetary values are presented in Table 1.

    Table 1: Datas on Northern Rock




    Dividend per portion



    Price ( Current year-Dec )




    Price ( Previous Year-Dec )




    Tax returns on Northern Rock Stock ( R )




    Table 2: Datas on Housing Monetary values

    Dec 2005

    Dec 2006

    Dec 2007

    Housing Monetary values *


    ? 201,090


    *The monetary values are based on Statistical informations related to mean lodging monetary values accessed

    Table 2 clearly high spots that the mean lodging monetary values over the period under inquiry. The addition in the monetary values in 2006 over 2005 was 9.3 % but was merely 8.4 % in 2007 over 2006.

    The consequence of lodging monetary values on the Northern Rock returns can be expressed in the signifier of the undermentioned arrested development equation:


    On making a arrested development analysis values of = -0.000034 and = 6.703 ( Refer Annexure 4 ( B ) for computations ) . Therefore, the equation of the fitted theoretical account is:

    R-square or Coefficient of finding is besides calculated( Refer Annexure 4 ( degree Celsius ) )to understand whether the theoretical account histories for the variableness in the returns. The R-squared value appears rather satisfactory at 71.9 % . In other words, by utilizing lodging monetary values as a forecaster, about 72 % of the discrepancy in Northern Rock returns has been explained. As R-square is greater than 50 % , it is NOT necessary to include other variables into the theoretical account.

    Hypothesis proving on Northern Rock’s sensitiveness to Mortgage monetary values is done at a P-value of 5 % . The nothing and alternate hypothesis may be expressed as follows:

    The t-statistic that has been calculated is around -0.000085( Refer Annexure 4 ( vitamin D ) ) asagainst the critical t-value at P= 0.05 based on t-tables which stands at 12.71 at grade of freedom of 1.Therefore, the estimated coefficient of lodging monetary values isnon reallysignificantly different from nothing. In other words the agencies are nonsignificantly differentat a chance of 5. Had it been significantly void hypothesis could hold been safely rejected. However, as the agencies are non significantly different, hence one can non be moderately confident that the returns of Northern Rock will differ from one another. However, there is about a 5 % opportunity of being incorrect in making this decision.

    Therefore, as David T. Llewellyn competently said, lodging monetary values have impacted the diminution in returns of Northern Rock, though non significantly, as there have been many other grounds excessively. However there is a caution in the instance of Northern Rock returns. The ‘non important difference in the mean values’ may be because of the undermentioned two grounds:

    • The fortunes for the bank have changed in 2007. From positive returns the returns have acutely become negative
    • The sample size is excessively little. A important difference in one twelvemonth can alter the illations wholly.


    two ) Predicting the Crisis

    A wide scrutiny of Northern Rock before the crisis highlights the undermentioned points:

    • It remained lawfully solvent as the nominal value of assets exceeded liabilities
    • Merely months before the crisis the bank had reported record net incomes
    • The quality of its assets was good,
    • The bank’s loan-loss record was good by industry criterions
    • For many old ages the bank was regarded as a star-performer in the metropolis and fiscal markets.

    So the inquiry arises, was it possible to foretell the crisis? A closer analysis could give a better image. For a closer analysis, the survey examines the Capital Adequacy ratio, Liquidity position and Altman’s mark.

    Capital Adequacy Ratio

    The capital adequateness ratio measures the bank’s ability to run into the demands of its depositors every bit good as other creditors. It is“the proportion of a bank’s assets that is held in the signifier of shareholder’s equity and certain of other defined categories of capital” (Law, 2006). The Basle Capital Convergence Accord specifies a minimal ratio of 8 % of capital to put on the line assets for Bankss. (Gram molecules et al, 1997 ; Law, 2006) . Monitoring the capital adequateness ratio can clearly highlight liquidness jobs and assist in foretelling a crisis. In this context Table 4 high spots the motion of the capital adequateness ratio of Northern Rock over the five twelvemonth period 2003 to 2007.

    Table 3: Capital Adequacy Ratios for Northern Rock






    Tier 1 Capital in ?m






    Entire Capital in ?m






    Hazard Weighted Assetss in ?m






    Capital Adequacy Ratio Based on Tier 1 Capital

    9.3 %

    8.7 %

    7.7 %

    11.7 %

    7.7 %

    Capital Adequacy Ratio Based on Entire

    14.3 %

    14.0 %

    12.3 %

    17.5 %

    14.4 %

    For Northern Rock the Capital Adequacy Ratio based on Tier 1 capital had declined over the period 2003-2005. However in 2003 and 2004 it was higher than the Basel benchmark of Capital Adequacy Ratio of 8 % . Not surprisingly, in the instance of Northern Rock the Capital Adequacy declined from 11.7 % in 2006 to simply 7.7 % in 2007. The worsening capital adequateness ratio signals troubled times in front. However the sudden rise for Northern Rock in 2006 and besides that in most of the old ages the ratio was higher than the Basel I benchmark would non hold helped in foretelling the approaching crisis. It was merely in 2007 when the ratio dipped significantly that the crisis state of affairs could be predicted with certainty.

    Analyzing Liquidity Status

    The province of deteriorating liquidness can bespeak an nearing banking crisis. Table 5 depicts the liquidness spread over the period 2003- 2007. It is clearly seeable from the tabular array that the liquidness spread has been widening. From ?12083.7 m in 2003 it had increased to ?30875.5m in 2006 ( An addition of 155 % ) . The 2007 figures do non bespeak an betterment as these are after the assistance provided by Bank of England in 2007 had been included.

    Table 4: State ofLiquid






    Entire Current Assets?m






    Current Liabilitiess ?m






    Liquidity Gap ?m

    ( 12083.7 )

    ( 23669.6 )

    ( 27505.40 )

    ( 30875.5 )

    ( 10351.9 )

    Current Ratio






    The current ratios as besides the liquidness spread highlight the liquidness hazard faced by the bank. There is a clear mismatch in the hard currency flows generated from current and expected assets, liabilities and derived functions. Through the deteriorating liquidness place the banking crisis could hold been easy predicted and preventative step should hold been initiated every bit early as 2003. The liquidness state of affairs has been so blue that in the hebdomad get downing 10 September 2007, despite the fact that the Company continued to raise financess at shorter continuances, the general tightening of longer term liquidness and the closing of the securitisation and average term markets meant it was necessary to set up a installation in instance such markets failed to reopen. Therefore an attack was made to the Bank of England to supply a loan installation to the Group.


    Altman’s Z-Score

    Banking crisis could besides hold been predicted had a theoretical account such as Altman Z-Score been applied to Northern Rock’s informations to see if there was a possibility of bankruptcy.

    Table 5 shows the Z mark for 2007, 2005 and 2003.

    Table 5: Fiscal Statement Figures

    2007 ?m

    2005 ?m

    2003 ?m

    Entire Assets ( TA )




    Entire Liabilities ( TL )




    Working Capital ( WC )



    – 12,083.7

    Retained Net incomes ( RE )




    EBIT ( EBIT )

    – 167.6



    Market Value of Equity ( EMillivolt)




    Gross saless ( S )








    Credit Health

    Serious Problems



    On the footing of the informations in Table 6 the Altman’s Z-score is calculated as 0.24 in 2007. As the Z mark is less than 1.81, it implies serious jobs. Merely a Z-score of 3 and above indicates a healthy province. Therefore, the mark clearly indicates all marks of bankruptcy. The Z-scores have been deteriorating in the old ages from Healthy in 2003 to Mediocre in 2005 to Serious Problems in 2007.

    In decision, it can be clearly said that the banking crisis could hold been predicted if the bank was supervised more carefully and was disciplined the minute jobs were detected. Following timely steps would hold prevented the Northern Rock crisis:

    • Early sensing of the jobs by subjecting the dorsum to frequent reappraisals and stress-testing
    • Preventing over-dependence on the Bank of England. Traditionally cardinal bank Acts of the Apostless as a lender-of-last-resort to illiquid solvent Bankss. However, Bankss tend to take inordinate hazards as they are cognizant of the support that they can anticipate from Bank of England. In order to restrict this moral jeopardy, this is done against good quality collateral and there is a punishment rate of involvement.
    • Have greater focal point on liquidness direction.


    • Banking ordinances should anticipate all Bankss to be wholly crystalline and do all revelations.
    • Proper monitoring by FSA.
    • Inclusion of certain instruments such as compulsory subordinated debt in the bank’s portfolio would hold helped the bank exercising more market subject. This is inline with what Calomiris ( 1998 ) and Evanoff and Wall ( 2000 ) had suggested

    three ) Possible solutions to the Northern Rock instance

    In the UK there is a Tripartite Memorandum of Understanding between the Treasury, FSA and Bank of England. In a fiscal crisis the ultimate duty for mandate of support operations by the Bank of England rests clearly with the Chancellor of the Exchequer. There are two chief grounds for this. First, it is in the nature of a political determination whether or non a bank is to be supported. Second, any such support exposes the revenue enhancement remunerator to a possible hazard in the event that the establishment proves non to be solvent. Therefore, this may non be a good solution to Northern Rock crisis.

    Besides support from the loaner of last resort, there can be four possible solutions to the Northern Rock bank:

    • Nationalization: This involves traveling Northern Rock from private ownership to province ownership. The UK authorities could hold taken over the Bank possibly without counterbalancing the stockholders. However, that may non be an attractive option either for the stockholders or the revenue enhancement remunerators.
    • Recapitalisation and restructuring: Recapitalisation would hold involved reconstituting Northern Rock’s debt and equity ratio with the purpose of doing a company ‘s capital construction more stable. While Northern Rock continued as a traveling concern and a listed entity an experient plc board should hold been assembled to take charge till the clip the personal businesss of the bank are brought into control. In add-on, the new board may work out a agenda of refunds while cut downing the loaning at the same clip.
    • Sale of the bank to the private party: With Bank of England’s support in the signifier of loans and warrants, all steps should be taken to sell the bank to the private sector party that the stockholders accept. The authorities does non necessitate to explicate its place on how much money will be lent to Northern Rock under new ownership and besides the continuance of the loans. The Chancellor should assist the stockholders of the bank pull its Sale Memorandum.
    • Securitisation of Debt:Northern Rocks bing debt of ?25 billion to the Treasury may be securitised and sold as bonds that would be guaranteed by the Government and sold efficaciously as gildings.


    Of these, recapitalisation seems to be the most appropriate option as it would reconstitute the bank on the footing of a coveted capital construction ratio and acquire refinanced consequently. Furthermore, it would be supported and monitored closely by the authorities boulder clay it is ready to take on.


    In decision it can be said that Northern Rock had several fault-lines with regard to:

    • The deductions of securitisation and a attendant over-reliance on short-run market instruments
    • The direction of LPHI hazards in Bankss
    • The sedimentation protection government in the UK
    • The institutional construction of fiscal ordinance and supervising

    These led to the crisis.

    The Northern Rock theoretical account proved to be feasible for several old ages till the clip the bank could roll-over short-run support on normal footings. However, the minute the serious liquidness squeezing occurred, LPHI hazard materialised and the bank was unable to roll-over its short-run support or roll-over support could merely be secured at high-interest rates. The liquidness squeezing chiefly occurred because of the sub-prime loaning crisis in the US. Thus, Northern Rock’s public presentation decidedly got impacted by the sub-prime crisis or the worsening lodging market.

    However, Northern Rock crisis could needfully hold been avoided had it been predicted and seasonably preventative steps taken. Preventive steps could hold taken the signifier of closer supervising and added ordinance. Closer supervising would hold detected worsening liquidness province and other jobs in the manner the bank had been working. Particularly as the concern theoretical account was exceeding the bank required comprehensive reappraisal. FSA in its ain reappraisal into the manner it supervised the Northern Rock bank, reveals that it failed to place the jobs with the bank at the right clip. Furthermore, unequal emphasis trials were applied to Northern Rock and whatever emphasis trials were there were non based on sufficiently inauspicious conditions or utmost premises. Even the Bank of England has judged that it did non hold adequate information about Northern Rock and possibly had disengaged excessively far from supervising of single Bankss for fright of infringing overly on the function and remit of the FSA ( Bank of England, 2007 ) . Added rigorous ordinances would hold disciplined the bank and forced it to acquire into hazardous state of affairss. In other words, better supervising and strict ordinance could hold prevented the crisis.

    Several possible reforms need to be considered in the banking system:

    • Inclusion of an component of co-insurance
    • The loaner of last resort should non exert velocity in supplying support when a bank becomes insolvent
    • Inclusion of compulsory subordinated debt in bank portfolio of instruments.
    • There should be a possibility of reassigning sedimentations to another establishment instantly a crisis emerges with a bank


    Finally, the solution for Northern Rock lied in either traveling in for Nationalisation or Recapitalisation or Sale to a private party. However, recapitalisation seems to be the best option.



    Appendix 1: Major Banking Crisis Cases


    Appendix 2: Beginnings of Funding ( in Percent )

    Beginning: Llewellyn, D.T. ( 2008 ) , “The Northern Rock crisis: a multi-dimensional job waiting to go on, Journal of Financial Regulation and Compliance Vol. 16 No. 1, 2008 pp. 35-58

    Appendix 3: Northern Rock Share Price, Jan 2007 boulder clay Suspension

    BBC ( 2008 ) . Northern Rock in Facts and Figures. Available online at:

    hypertext transfer protocol: //

    Appendix 3

    BBC ( 2008 ) . Northern Rock in Facts and Figures. Available online at:

    hypertext transfer protocol: //

    Appendix 4: Working Notes

    a )Tax returns on Northern Rock

    2005 =[ ( 30.1+943 ) / 781.5 ] – 1= 0.245

    2006= [ ( 36.2+ 1178 ) / 943 ] – 1= 0.288

    2007= [ ( 0+ 84 ) / 1178 ] – 1= -0.929


    B )Arrested development Analysis

    Arrested development Analysis: Consequence of Housing Monetary values on Tax returns on Northern Rock Stock


    Housing Monetary values

    ( ? )


    Tax returns

    ( P )























    Ns =3




    i?“ Ten2=121807729316



    i?“ Yttrium2 =1.006

    Calculation of

    Calculation of


    degree Celsiuss )Calculation of R-square

    vitamin D ) T-statistic

    Standard mistake =SE

    t-score =

    vitamin E ) Altman’s Z-Score

    Altman’s Z-score has been arrived as:




















    Mentions and Bibliography

    1. Annual Reports of Northern Rock available online on hypertext transfer protocol: //
    2. Bank of England ( 2007 ) .Fiscal Stability Report. Bank of England, London.
    3. Bell J & A ; D.L Pain ( 2000.Leading Indexs Models of Banking Crisiss: A Critical Review. Financial Stability reappraisal, December. Bank of England
    4. Calomiris, Charles W. 1998.The IMF as Imprudent Lender of Last Resort. Cato Journal, May
    5. Carmichael, J. , Fleming, A. and Llewellyn, D.T. ( 2004 ) .Aligning Financial Supervisory Structures with Country Needs. World Bank Institute. Washington. DC.
    6. Caprio, Gerard Jr. , and Daniela Klingebiel. 1996. Bank Insolvencies: Cross-Country Experience. Policy Research Working Paper 1620. World Bank, Washington, D.C.
    7. Capiro, Gerald, and Daniela Klingebiel ( 1997 ) . Bank Insolvency: Bad Luck, Bad Policy or Bad Banking? . In: M. Bruno and B Pleskovie ( explosive detection systems. ) , Annual World Bank Report IBRD, Washington
    8. Davis, E.P, ( 1999 ) . Constructing an Incentive Compatible Safety Net, Journal of Banking and Finance, 23 ( 10 ) , pp: 1499-1519
    9. Englund P. ( 1999 ) .The Swedish Banking Crisiss: Roots and Consequences. Oxford Review of Economic Policy, vol. 15, No. 3, pp. 80-97.
    10. Evanoff, Douglas D. and Wall, Larry D. SubordinatedDebt and Bank Capital Reform( November 2000 ) . FRB Atlanta Working Paper No. 2000-24
    11. Gersbach H. , Wenzelburger J. ( 2003 ) . The Exercise of Banking Crisiss: A macroeconomic position. CESifo Economics Studies, vol. 49, No. 2, pp. 233-258.
    12. Goodhart C and D Schoemaker ( 1995 ) .Institutional Separation between Supervisory and Monetary Agencies. FMG Particular paper, London: London School of Economics
    13. Goodhart, C. ( 1999 ) .Myths about the Lender of Last Resorts.FMG Special Paper 120, London: London Scholl of Economics
    14. Healey, J. ( 2001 ) . Fiscal stableness and the cardinal bank: international grounds. in Brealey, R. ( Ed. ) .Fiscal Stability and Central Banks.Routledge. London.
    15. Housing statistics available online from
    16. Kunt, D.A and Detragiache, E. ( June 1998 ) . Fiscal Liberalization and Financial Fragility. International Monetary Fund ( IMF ) – Research Department
    17. Law J. ( 2006 ) . Capital adequateness ratio. A Dictionary of Business and Management. Oxford University Press, Oxford Reference Online.
    18. Llewellyn, D.T. ( 2004 ) . Institutional construction of fiscal ordinance ad supervising: the basic issues. in Carmichael, J. , Fleming, A. and Llewellyn, D. ( Eds ) .Aligning Financial Supervisory Structures with Country Needs. Chapter 2, World Bank Institute, Washington, DC.


    1. Llewellyn, D.T. ( 2008 ) .The Northern Rock Crisis: A Multi-dimensional Problem Waiting to Happen. Journal of Financial Regulation and Compliance Vol. 16 No. 1, 2008 pp. 35-58
    2. Luna-Martinez, J. and Rose, T.A. ( 2003 ) . International study of incorporate fiscal services supervisors. Policy Research Working Paper. 3096. World Bank, Washington, DC.
    3. Masciandaro, D. ( 2003 ) . Cardinal Banks and Single Authorities: A Delegation Puzzle. Bocconi University. Milan.
    4. Moles P. , Terry N. ( 1997 ) Basle Capital Convergence Accord.The Handbook of International Financial Footings. Oxford University Press 1997.
    5. Oosterloo, S. and de Haan, J. ( 2003 ) . A study of international models for fiscal stableness. Occasional Studies. Vol. 1 No. 3. Available online from
    6. hypertext transfer protocol: // xml=/money/2008/02/19/bcndenham119.xml
    7. Pollock, Ian ( 26 March 2008 ) .Analysis: FSA ‘s Many Failings. BBC News. Available online from hypertext transfer protocol: //
    8. University of Cambridge ( 26 February 2008 ) . Can a bank crisis interrupt your bosom? Available online from hypertext transfer protocol: //


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