My Blog

September 14, 2007

This entry is not directly about China, but it may have indirect bearing on China by suggesting how sudden, unexpected and indirect the sequence of events leading to a bank run can be.  Rapid growth, weak transparency, and major changes in business strategies that are not anchored in very strict risk management can be a powerful combination in bringing a bank down when the very good economic and liquidity conditions that underpinned its growth suddenly change, and as this English example shows, panic can quickly become “irrational”.  Not even a Bank of England rescue was enough to chase away depositors clamoring for their money. 

It always seems a little anachronistic to worry about bank runs, but we continue to have them – usually in ways that are very different from those of the movie “It’s a Wonderful Life”, but as Northern Rock shows, not always.  This is excerpted from Friday’s Financial Times:

The turmoil in global banking hit the streets of Britain on Friday as thousands of Northern Rock customers queued up to withdraw their savings from the UK mortgage lender after it was rescued by the Bank of England.  As regulators and politicians called for calm, Northern Rock – Britain’s fifth-biggest mortgage lender – scrambled to contain the fallout after it became the first British bank in decades to be bailed out by regulators. One person close to the situation said customers had withdrawn about $2bn Friday but Northern Rock declined to comment on the figure, which would amount to 4 per cent of its deposit base.

 

The rescue demonstrates the risks from a decade of financial innovation in the capital markets, which allowed a small regional lender to wield financial clout far greater than its network of 76 branches would suggest.  It also shows how the turmoil in the financial system that resulted from excessive lending to Americans with patchy credit histories triggered the failure of a bank with no direct links to the US mortgage market.

Saturday’s Financial Times had more on the topic:

Some had been up all night worrying, others had spent an hour travelling or battling jammed websites and all were determined to do one thing at a Northern Rock branch on Friday: get as much of their money out as they could.  “We are elderly and this is our life saving,” said Sheila Smith, who came with her husband, Arthur, to withdraw all their money from the bank’s Moorgate branch in central London. “We can’t afford to lose it.”

 

A 61-year-old retired health service consultant from Sidcup was following suit, having spent more than an hour getting into the city after a morning of failed phone calls to his local branch.  “I put all my savings in one basket and the best thing to do is to get out of this basket,” he said.  Michael Ribotham, 74, could not see any point in leaving his money in a bank with such big problems. “I’m not young and don’t have a chance to make it back again.’’

In another article on the same day, someone with the wonderful name of Scheherade Daneshkhu writes:

Could the problems affecting Northern Rock spread to other banks and building societies? That was the question on the minds of millions of homeowners on Friday.  The British Bankers’ Association moved swiftly to allay the fears of mortgage customers and savers. “Everyone should calm down and refrain from making simplistic comments in a very complex area which just cause unnecessary worry and concern,” it said reprovingly.

Finally in an Opinion piece John Gapper writes:

Actually, there is something to worry about, even if those queuing outside Northern Rock branches to withdraw their money on Friday were (understandably) over-reacting. The Bank of England does not bail out banks every day. The last comparable wobble was the secondary banking crisis of 1973-74, in which the Bank of England launched a “lifeboat” for troubled small banks and National Westminster Bank nearly foundered.

 

Here is the blurb to Margaret Reid’s book on that crisis: “Abundant credit in a liberalised financial system led by a government hell-bent on growth provided a hot-house atmosphere for a breed of self-styled financial entrepreneurs...Their reign was brief, foundering in a mix of political chaos, currency crises, rebounding interest rates, over-investment in property and the inevitable and dramatic change in that most fickle of ingredients – confidence.”

 

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