Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Sun, 18 Nov 2007

Deposit Insurance and Northern Rock

The flurry of comments and discussion that followed Mervyn King’s interview to the BBC on November 6, 2007 have led me to the conclusion that the true lessons from Northern Rock are largely about deposit insurance and not about bank supervision.

Mervyn King’s interview about the handling of Northern Rock prompted a series of comments last week in the Financial Times by Philip Stevens, Willem Buiter and Martin Wolf. This has prompted me to revisit Northern Rock which I blogged about last month here and here. I am even more convinced than before that the Northern Rock episode does not reveal fundamental flaws with the model of unified regulation and separation of monetary policy from bank supervision. I also think that King’s decision to provide liquidity only at penal rates and against top class collateral was quite correct. Mervyn King said in his interview:

If you look at what the European Central Bank lent to banks through their auctions that they conducted, relative to the size of the banking system they lent an average of 230 million pounds per bank participating in their auctions. Northern Rock needed something closer to 25 billion, 100 times larger than the average amount which the European Central Bank was lending to banks through their auctions. The scale of the funding that was needed was staggeringly large.


So could we have had an auction that was sufficiently large that all the banks would have got 20 to 30 billion and Northern Rock wouldn’t have been noticed in that process? Well, that would have been an auction on a scale 50 odd times that which any other Central Bank had engaged in. And I’m absolutely convinced that the first question you would have asked on that day is: “What on earth must have happened to the entire British banking system to have merited an auction of that size?” We were doing this not to bail out the British banking system, which didn’t need bailing out, but actually to get money into one institution that needed it.

In my view, the lessons from Northern Rock are:

Posted at 17:44 on Sun, 18 Nov 2007     View/Post Comments (0)     permanent link