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Description
Introduction
September brought the United Kingdom its first mass market bank run. Although there had been bank runs in the nineteenth century, with the last in 1866, very few people then had bank accounts so the runs were not in any sense comparable with what happened to Northern Rock, which showed a failure of mass retail banking.
After any crisis of this type it is easy to say that there must have been inadequate regulation. At the same time it has to be remembered that excessive regulation has perhaps as many drawbacks as inadequate regulation. In the nature of things, a crisis arises from events that regulators had not anticipated. If they had anticipated them the crisis would not have occurred. Nevertheless, one possible weakness of the current system is that responsibility is split between HM Treasury, the Bank of England and the Financial Services Authority. It seems that this split arose because, in 1997, the Treasury was concerned that, if the Bank of England had sole responsibility for banking regulation it would be all too ready to bail out banks which ran into difficulties. King (2007a) has, however, denied that the tripartite arrangement is a problem, despite the fact that, as far as one can see, the regulatory system did not respond to earlier warnings from the Bank of England about credit markets.
Background
The crisis had its roots in sub-prime lending in the United States. Sub-prime mortgages, like other mortgages, were converted into traded securities with complex structures. European banks bought these securities in the belief that they were diversifying their portfolios but without any real understanding of the risks that they were running. The crisis broke on 9 August, when Paribas reported that it was impossible for it to value some of the mortgage-related securities which it owned. Since many banks were believed to have invested in similar securities, banks felt that they did not know enough about the solvency of other banks to which they might lend. As a consequence lending on the inter-bank market stopped.
This meant that banks with wholesale deposits falling due were unable to renew them in the wholesale markets. They therefore looked to central banks to provide the liquidity which was needed to replace that which was no longer available in wholesale markets. While the Federal Reserve Bank, the European Central Bank and the Bank of England all made liquidity available, the Bank of England saw no reason to change the standard terms on which it would do so, simply because commercial banks had found that they needed to use those standard terms. By contrast the other two central banks made funds available on terms more favourable than usual. When it became public that Northern Rock was receiving help from the Bank of England, depositors sensibly concluded that their savings were at greater risk there than elsewhere, leading to the run on Northern Rock which ended only when the Chancellor of the Exchequer announced a government guarantee for their deposits.
Regulatory issues
The crisis was one of liquidity and raises the question whether the regulation of bank liquidity needs to change. Some regulatory changes which might be considered following the debacle are plainly inappropriate. The text-book model of banks assumes that they keep a constant proportion of their liabilities as liquid assets and such ratios have, from time to time, found their way into the regulatory framework. For example, in the 1960s the UK clearing banks were expected to keep 28 per cent of their liabilities (1) in liquid form. However, if such ratios are mandatory, then the liquid assets are... |
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