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Credit crunch- Case of Northern Rock requiring official assistance /intervention

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Paul B.
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  1. Introduction
  2. Credit crunch- A historical overview
  3. Role of regulatory authorities
  4. The run on Northern Rock
  5. Conclusion
  6. Bibliography

What is happening in the developed world today is one of the worst economic meltdowns of modern history. The financial institutions are trembling like nothing else whereas the impacts of such a failure of financial institutions are clearly felt by the rest of the world as well. The reductions in consumer spending, the increasing level of unemployment as well as forecasts of negative growth are some of the aftereffects of this economic downturn.

In the wake of these crises, there are many important concerns which are being expressed as the potential effects of the credit crunch can easily be felt against other economic variables too. (Campbell, 2008).Apparently, the current crisis may be attributed to the subprime lending made by the different financial institutions. However, at the core of it is a whole plethora of different variables which are not only correlated with each other but also created a combined effect on different macroeconomic variables too. The failure of financial institutions to regularly check in their appetite for taking more risk not only resulted into the current credit crunch but also indicated the degree of the regulatory control over such institutions to discipline their behavior.
Northern Rock is such a financial institution in UK which required intervention from the government because of its apparent failure to sustain the losses incurred due to subprime mortgage episode.

In this research study, the current credit crunch will be discussed with special focus on Northern Rock as a firm requiring official intervention.

[...] The primary factor behind the failure of Northern Rock was the fact its business model was unique and relied heavily on the capital markets for securing funds to make the lending. However, as the world's capital markets started to shrink owing to credit crisis in US, the same effect was carried over to the capital markets of the UK too. Thus depositors started to withdraw their money from their accounts in Northern Rock- according to one estimate more than one billion pounds were withdrawn- creating serious funding problems for the bank to continue to remain solvent in foreseeable future. [...]


[...] Northern Rock too engaged into such business practices where it went far too ahead of its capabilities to manage the down side risk of such transactions. (Atkinson, et.al. 2008). Northern Rock The run on Northern Rock was one of the most severe blows to the financial system of UK as many realized how fragile UK's financial system can be as this run unfolded a burning volcano in the financial sector of UK.(Keasey & Vernoesi,2008). Northern Rock was the fifth largest mortgage lender in the country and run on it was the first on any British Bank in almost a century as the prevailing funding related problems forced the bank to seek official help from the British Government. [...]


[...] due to their past credit history. Therefore, under normal banking rules and practices, lending to such borrowers are riskier as in comparison to other borrowers. It is because of this reason that such borrowers are categorized as subprime and are charged relatively higher rates on the lending made to them. Historically, banks were more conservative in their lending practices and avoided to lend to such borrowers who lacked the capability to repay. However, with the innovation in the financial markets corroborated by liberalization of financial markets allowed financial institutions to innovate and roll out products which carried relatively high risk. [...]

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