In September 2007 rumours began to circulate in Britain that the Newcastle-based bank Northern Rock was in financial difficulty. As these rumours gained in credibility, retail depositors rushed to withdraw their savings fearing that they would be lost if the bank collapsed. What these depositors were doing in public, as they formed queues outside the bank’s branches, had already happened behind the scenes throughout August. In the wake of the sub-prime lending crisis in the US, banks had become weary of lending to fellow banks in case they would not be able to repay them. That created problems for banks like Northern Rock as it had adopted a business model that made it dependent upon short-term borrowing from other banks to finance its aggressive expansion of long-term mortgage lending. As new funds provided by other banks dried up and the date on which many existing loans had to be repaid, Northern Rock had no alternative but to seek assistance from the Bank of England, the traditional lender of last resort under these circumstances.
The ‘run’ on Northern Rock
It was while the required assistance was being negotiated, involving a protracted delay because responsibility no longer lay with the Bank of England alone but was shared with the FSA and the Treasury, that the story broke that Northern Rock was in difficulty. Faced with panic among the depositors, and the possible spread of their actions to all British banks, the UK government was forced to intervene and guarantee bank deposits. In many ways Northern Rock was unfortunate as the timing of its borrowings from other banks put it first in line to require assistance when these funds dried up. It could equally well have been any of the other ex-building societies and even a number of those that had not de-mutualised, as they were all operating the same business model.
If the crisis had ended with the collapse of Northern Rock, and its belated nationalisation early in 2008, then it would forever have been associated with that single bank and its cause blamed on poor management. Even if the crisis had stopped with the disappearance of all those building societies that had converted into banks, as did happen, then the story would be about a failed experiment and attributed to the transformation of the British financial system begun by Mrs Thatcher’s Conservative government in the 1980s. However, even in Britain the crisis went much further than a set of specialist mortgage lenders, as these were not too big or interconnected to fail as none played a major role in the provision of short-term credit or were central to the operation of the payments system. With hindsight the need for the government to intervene might have been subject to serious questioning along with the scare tactics used by the media in pursuit of a scoop. Instead, the near collapse of the two largest Scottish banks, Royal Bank of Scotland (RBS) and HBOS, and the massive intervention required by the government to save them, is what really brought the crisis to a head in Britain.
The role of RBS and HBOS in the financial crisis
As Scottish banks, neither RBS nor HBOS were too big or interconnected to fail, though the effect on one particular part of the UK, namely Scotland, would have been devastating. The real problem was RBS, which had taken over one of England’s largest banks, NatWest, and so placed itself at the heart of short-term lending in the UK and occupied a central position within the payments system. NatWest was too big and too interconnected to be allowed to fail as was recognised at the time, and was why the UK government had no alternative but to intervene to prevent its failure. In contrast, HBOS was the combination of a locally important bank, the Bank of Scotland, and an ex-building society, Halifax. Though both of these components were important in their own ways neither was central to the operation of the UK financial system, and so HBOS could have been allowed to fail and its assets acquired by other banks. In many ways that was what happened with the takeover by Lloyds, a large conservatively run English bank.
Unfortunately, the scale of the problems at HBOS overwhelmed Lloyds forcing the government to intervene to save the combined business from collapse. However, the problems at Lloyds/HBOS are close to being resolved as the Lloyds operation was always fundamentally sound. In contrast, solving the problems at RBS has proved to be more intractable as the whole business, including NatWest, had been run aggressively prior to its near-death experience. Nevertheless, if the financial crisis in Britain had ended with the collapse and rescue of the two Scottish banks, then the story would be one relating to why two small Edinburgh banks had been allowed to acquire large English banks but were politically immune from takeover by the big London-based banks, despite attempts to do so in the past. In turn questions would be raised about why the crisis in Britain revolved around banks managed from the likes of Edinburgh and Newcastle while those located in the City of London were relatively unscathed, as would have been if Lloyds had not been tempted by HBOS.
The collapse of Lehman Brothers shifted attention away from the particular problems inherent in Britain’s own banking system by submerging them into a global financial crisis. This let the politicians off the hook, whether it was the Conservatives and their encouragement of greater competition in banking leading to increased risk taking or Labour who were architects of the failed Tripartite regulatory structure and stoked up a credit bubble. It also let the media off the hook for their irresponsible reporting of the emerging crisis at Northern Rock, and the effects it had on public confidence in banks. The Bank of England was also left off the hook in trying to explain why they had taken so long to act in the case of Northern Rock and then failed to support a rescue that would have saved the depositors and punished the shareholders and management without providing a universal guarantee for all banks.
Left on the hook were all British banks regardless of their behaviour before, during and after the crisis. Thus, instead of detailed inquiries that would identify the strengths and weaknesses of UK banks, and why they proved less than resilient in 2007/8, the collapse of Lehman Brothers led to all banks the world over being identified by the media as those responsible for the crisis. Subsequent revelations relating to product miss-selling or market manipulation, whether related to the global financial crisis or not, have helped fuel a banker witch-hunt as they became the media scapegoats in the search for simplified explanations for what had happened.
In light of the global financial crisis, lessons from Britain and elsewhere show that banks are highly interconnected, this makes them resilient, but also exposes them to risk as in the case of Northern Rock. Banks will always fail, but not all will lead to a global financial crisis. The banking crisis in Britain has demonstrated that decisive action must be taken to prevent instability within the financial system, rather than uncoordinated action, which took place in public view. While bank failures may be inevitable global financial crisis need not be so and because of the involvement of several British banks, the UK’s international financial sector has taken on severe reputational damage. If it is to recover it must rebuild its reputation as a global financial centre.
Professor Ranald Michie is a Professor in the Department of History at Durham University and one of the UK’s renowned financial historians. He is a lead researcher on the Tipping Points project based at Durham’s Institute of Hazard, Risk and Resilience.