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Northern Rock bank collapse
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| Words: 1791 | Submitted: 19-Jan-2012
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Descriptionan assignment describing the reasons behind Northern rock collapse
MONEY AND BANKING ASSIGNMENT
Northern Rock bank collapse
The August in the UK often brings the cool and comfortable weather to everyone here, but it was not the same in August 2007 when they had to witness the collapse of Northern Rock that its failure was totally contrary to what people had known about it before.
Northern Rock was established in 1997 from the conversion of Building Society into bank status when the potential development of mortgage market was judged to bloom. Indeed, its dramatic increase was presented through the value of total asset in 2006 of over £100 billion, six times more than it was at the end of 1997 with the value of £15.8 billion. Although standing at one of seven largest banks in the UK, Northern Rock in some way was considered as the No.1 mortgage lender and persuasively entered the FTSE 100. To accomplish these successes, Northern Rock adopted four methods of mobilization: retail savings, covered bonds, securitized notes and wholesale funding. By the end of 2006, its securitized assets accounted for approximately 90% of total assets in contrast with the fall of proportion of retail deposit from 62% in 1997 to approximately 23% in 2006. This shows Northern Rock’s main reliance on the securitization and wholesale funding which is not the traditional model –“originate to hold” but “originate to distribute” (House of Commons, 2008: 14). Northern Rock built up a complex securitization process in which all mortgaged assets were transferred into Special Purpose Vehicles -“Granite” located in “tax haven” Guernsey to transform the long-term lending into short-term loans. The Granite had its duty of parcelling up all the mortgaged assets and sold them to the investors, but the beauty of this model is that Northern Rock did not legally own Granite and treat securitized assets as off balance sheet vehicles. This obviously created Northern Rock an opportunity to avoid capital requirement under Basel II but still had the right to consolidate Granite’s reports on main balance sheet. The extreme balance sheet and successful model of Granite brought Northern Rock incredibly development and many channels of mobilization at the time.
This low-probability-high-impact model might be under control if securitization and lending process were still in a benign market (Franco Bruni and David T. Llewellyn, 2009: 17). I call it high risk due to the over reliance on short-term wholesale funding to lend up to 25-year loans. It was this method of mobilization that brought Northern Rock so plentiful cheap source of capital without sufficient strategy to cover the mature risk transformation from its business operations. The triggering point came from the BNP Paribas’s closure of 3 SIVs for subprime mortgages to respond the default of USA ...
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