Monday, October 01, 2007

More trouble for Northern Rock

(UK government secures savings at all banks)

On Monday, the British government announced plans to guarantee the security of personal savings accounts at all banks up to $70,000 (£ 35,000). The current provisions allow for 100% coverage of the first 2,000 ($4,100) pounds in personal savings, and 90% coverage for the next 33,000 (($67,500) pounds. Last month, the government extended the same protection to customers at Northern Rock Bank, in an effort to stop the flood of depositors pulling their savings from the troubled bank. Many depositors cited the lack of full coverage as a contributing factor in their decision to move their funds elsewhere.

Treasury Chief Alistair Darling will seek legislation to increase the coverage to as much as $200,000 (£ 100,000). In an interview with the British Broadcast Corp. Darling suggested that the higher limit on protecting savings in Britain could be provided by a system based on the US Federal Depost Insurance Corp. Currently, the financial services industry and banks fund the deposit guarantee system in Britain. In contrast, in the US, the Federal Deposit Insurance Corp guarantees deposit accounts, savings and loans. Deposit accounts, savings and loans are each insured up to $100,000, and individual retirement accounts are covered up to $250,000. In the event that a bank fails, the federal deposit insurance fund covers the losses. The FDIC administers the fund, which is funded by premiums paid by financial institutions.

However, Angela Knight of the British Bankers Association cautions that raising the guarantee to £ 100,000 will be expensive, and may result in unwelcome consequences to customers in terms of fees and lending structures. She also noted that Britain has never had a bank fail, suggesting that perhaps the British government should prioritize its investigation of the causes behind the fall of Northern Rock Bank before exploring system wide changes.
Northern Rock shares dropped another 26% on Monday to 132 pence ($2.71) per share on the London Stock Exchange. Traders reported that the price drop was the result of a report in The Sunday Telegraph reporting that Northern Rock bondholders were organizing to hire advisers, creating fear with shareholders that bondholders would gain priority claims if the company is liquidated.

Questions for Discussion

1. Is the demise of Northern Rock Bank a single, isolated incident, or does it hint of larger problems in the UK banking structure?

2. Is the British government's move to secure all savings accounts premature?

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