This article is taken from Merryn Somerset Webb’s free weekly personal finance email, MoneySense. Click here to sign up now: MoneySense
“The Northern Rock is a sound and safe bank and there is absolutely no reason for either mortgage customers or savers to worry. All today’s announcement from the Bank of England, Treasury and the Financial Services Authority means is that the Northern Rock has had to make alternative arrangements to meet its normal everyday short term borrowing requirements. The British banking system is carefully regulated and overseen which ensures that all banks operate safely and prudently in the interest of their customers.”
Sounds reassuring, doesn’t it? But is it true? Not true enough. The fact is that there is enough doubt about the future of Northern Rock that not only should savers be worrying, but it makes perfect sense if you have an account there to nip down to your nearest branch or if you can’t find one (there are only 70 odd, which is part of the problem) to keep banging away at the website until you finally make it work. The BBA says we should all “calm down” but to be honest the more rational response is probably to panic.
The Bank of England has made it very clear that Northern Rock was technically solvent on Friday and that it is helping out only on that basis. The suggestion being that were Northern Rock (or Northern Rank as my interviewer on the BBC called it – probably by mistake – this morning) not solvent it would not be deserving of government – i.e. our – help.
The problem here is twofold. First Northern Rock won’t necessarily stay solvent. And even if it does we can’t be completely sure that the BoE will keep its lines of credit open indefinitely if a buyer for the business doesn’t turn up soon.
You see, the BOE has not actually guaranteed anything to the bank’s unfortunate depositors. Northern Rock can only keep on borrowing from it as long as it can supply the collateral to back up the borrowings and it is far from certain that it has enough of that, and particularly enough of reasonable quality, to cover depositors removing all their cash and to replace all the money it can’t borrow in the money markets any more (see our recent Money Morning email Will there be a run on Northern Rock? for details on how Northern Rock’s business works). This, says Breakingviews.com means that, while the BoE is clearly offering “a very large line of credit…it is not totally irrational for depositors to get their cash out.”
And even if Northern Rock can get all the cash it needs off the Bank of England for now, how long can it keep doing so for? If the run on the bank continues more and more questions will be asked about its solvency, says Breakingviews. “After all Northern Rock is having to pay a penal rate – understood to be 7.25% – on the money it borrows.” But its assets (the mortgages it holds) don’t yield that much. “Up until now it has been a profitable bank. But the more it has to rely on expensive Bank funding the more likely it could tip into loss – something that could undermine its solvency.”
I don’t think the risk of depositors losing money is very big – in fact I think it is tiny. This is not a government who can afford to see thousands of voters coming face to face with the consequences of the collapse of the credit bubble it has been aiding and abetting for so long. But the point is that, however minute it is, the risk is there. And that’s why if I had money in Northern Rock I would take it out. Today.
Sure, the Financial Services Compensation Scheme appears to guarantee some of your money. You get your first £2,000 back in full plus another 90% of the next £33,000 (so a grand total of £31,700). But even if you have less than £2,000 I still can’t see why you’d leave it there – if the unthinkable does happen just imagine the bureaucracy and delays you’ll have to put up with to get your money back. It’ll be far more boring and time consuming than queuing for an hour now.
And one last thing on this: the FSCS’s own website says ‘it is still possible to conceive of a default (or a combination of defaults) so big as to be beyond FSCS’s ability to pay compensation up to ourlimits.” Truth is that if something truly horrible happens, say another bank gets into trouble, you might not even get your £2000.
It’s also worth noting at this point that Northern Rock rates are hardly the best on the market anyway (what with their splendid strategy of borrowing all the money they needed to lend out in mortgages they haven’t had much incentive to encourage depositors to leave money with them). Click here to find better rates: Best deals. You will find that quite a lot of the very best rates come with some sort of catch attached to them – they pay no interest in any month you withdraw money and that sort of thing. But on the plus side, very few of them come with the risk that their provider might be about to go bankrupt.
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