United Kingdom: Northern Rock Emergency Liquidity Program, 2007

Emergency Liquidity Facilities

The BoE extended emergency liquidity support to Northern Rock on September 14, 2007, to help the bank fund its operations (BoE 2007c). Before the crisis, Northern Rock had a funding structure that was heavily reliant on its GBP 50 billion program called Granite, whereby the bank raised wholesale funding secured by its mortgage loans held in special purpose entities (BoE 2007d; Northern Rock 2009; Patrick 2007). At the end of 2006, 89.2% of the bank’s assets were residential mortgages, and its liabilities were largely wholesale funding sources (House of Commons 2008). By August 2007, Northern Rock’s credit default swap spreads were widening and its share price falling as broader credit and money market conditions deteriorated. By mid-September, Northern Rock was able to roll over debt but only at shorter and shorter maturities (BoE 2007d). The general tightening of longer­-term liquidity, the shutdown of the securitization and medium-term funding markets, and pressures in short-term wholesale markets posed problems for funding Northern Rock’s warehouse (that is, mortgage loans preparing for securitization). Thus, Northern Rock approached the BoE for liquidity support during the week of September 10, 2007 (BoE 2008b; Northern Rock 2008a). Figure 2 shows the composition of Northern Rock’s liabilities in December 2007 compared to June 2007.

Broad-Based Deposit Insurance

Established in 2000 by the Financial Services and Markets Act, the Financial Services Compensation Scheme (FSCS) outlined depositor protection when a financial institution was unable, or likely to be unable, to meet its liabilities to depositors. Before October 2007, the FSCS guaranteed GBP 2,000 plus 90% of the deposits between GBP 2,000 and GBP 35,000 (HM Treasury, FSA, BoE 2007; Shin 2009). Thus, the maximum deposit insurance was GBP 31,700. On October 1, 2007, the FSA announced that maximum compensation under the FSCS was increased to 100% of the loss incurred on deposits up to GBP 35,000 (HM Treasury, FSA, BoE 2007). For more information, see Vergara (2022).

Northern Rock Guarantees

The September 14 announcement of the liquidity facilities led to a retail deposit run of at least GBP 4.6 billion on Northern Rock in the following days (BoE 2008c; Collinson 2007; House of Commons Public Accounts Committee 2009). The same day, shares fell in Alliance & Leicester, Bradford and Bingley, HBOS, and Barclays, amidst fear of contagion (Collinson 2007; Panja 2007).

On September 17, 2007, the chancellor announced that the government would fully guarantee Northern Rock’s existing deposits (BoE 2007d; HMT 2007). Days later, HM Treasury confirmed the guarantee to cover existing and renewed unsecured wholesale funding as well. On October 9, HM Treasury extended the guarantee to cover new retail deposits, those made after September 19, as well (BoE 2007d). On December 18, 2007, HM Treasury extended the guarantee again to include:

all unsecured retail products, all uncollateralized and unsubordinated wholesale deposits and wholesale borrowings, all payment obligations under any uncollateralized derivatize transactions, and all obligations of the Company to make payments on the repurchase of mortgages under the document for the Granite securitization program. (Northern Rock 2008a)

HM Treasury said the guarantee would last as long as the current period of financial instability persisted and would have three months’ notice before termination (HMT 2009). In exchange, Northern Rock paid a fee to HM Treasury (Northern Rock 2008a).

Northern Rock Restructuring, Capital Injection, and Resolution

HM Treasury nationalized Northern Rock on February 22, 2008, whereby the Treasury Solicitor took the bank into public ownership (BoE 2008b; BoE 2008d; House of Commons Public Accounts Committee 2009; Mor 2018). As of February 29, 2008, in addition to the liquidity facilities in Figure 4, Northern Rock also had GBP 1.2 billion of outstanding reverse repo agreements—GBP 0.1 billion of which were held with the BoE’s Banking Department and GBP 0.3 billion of which were held with the BoE’s Issue Department. On December 31, 2008, another GBP 0.1 billion were placed with the Banking Department (BoE 2008b). On March 31, 2008, HM Treasury approved a restructuring plan with four strategic priorities: (a) repay the emergency liquidity facilities, (b) align the bank’s organization and operations to reflect a new commercial strategy, (c) build a stand-alone funding and capital position, and (d) strengthen the risk and control environment (Northern Rock 2009).

Northern Rock continued to have higher-than-expected losses and was at risk of breaching its capital requirement. In July 2008, Northern Rock asked HM Treasury for GBP 3 billion in additional share capital, potentially GBP 4.5 billion to GBP 6 billion if losses increased. Northern Rock enjoyed regulatory relief on its capital position while the government considered options. HM Treasury decided against (a) staying the course with the original restructuring plan and (b) immediate closure of the bank, because both options were poor value for money. Thus, HM Treasury considered two more preferable options: (c) selling Northern Rock’s deposits to another bank and winding down the remaining mortgage assets in a separate, publicly owned company and (d) splitting Northern Rock into good and bad banks (NAO 2012). HM Treasury split Northern Rock into good and bad banks. The good bank took all preexisting customer savings accounts and some preexisting mortgage accounts. The bad bank became an asset management vehicle with GBP 75 billion in total assets, of which GBP 54 billion were mortgages and unsecured loans as of January 1, 2010. The asset management vehicle did not hold deposits or offer additional mortgage lending (Mor 2018). The government sought to sell assets to the private sector as quickly as possible because holding assets to maturity risked default on the part of borrowers (NAO 2016).

In January 2010, the government injected GBP 1.4 billion of equity to capitalize the new good bank after the split of Northern Rock. By late 2011, losses on the GBP 1.4 billion capital injection amounted to GBP 480 million (Mor 2018; NAO 2012).

For the funds recuperated from Northern Rock’s resolution via sale of the good and bad banks, see Key Design Decision No. 7, Source and Size of Funding.

UK Legal Authority

Although it did not have explicit statutory authority, the BoE enjoyed broad, discretionary powers for emergency liquidity assistance to banks. Tripartite memoranda of understanding since 1998 have been the guiding framework for emergency lending decisions (IMF 2011).

Under the Memorandum, the BoE is responsible for “undertaking, in exceptional circumstances, official financial operations . . . to limit the risk of problems in or affecting particular institutions spreading to other parts of the financial system” (BoE 2006).

Paragraph 13 of the Memorandum covers the process for assessing the seriousness of a crisis and considering appropriate measures. Paragraph 14 addresses the possibility of a need for operations beyond the BoE’s published framework. The memorandum says that the chancellor of the Exchequer has ultimate legal responsibility for authorizing support operations during exceptional circumstances (BoE 2006). The BoE’s press release announcing the facilities said the chancellor authorized the BoE to provide the facilities and refers to the Memorandum (BoE 2007c).

UK and European Union laws, including market abuse legislation, required the disclosure of emergency liquidity granted to Northern Rock (see Key Design Decision No. 6, Communication and Disclosure) (Reuters 2007a). At the time, UK authorities had to integrate (a) their own legislation, the Financial Services and Markets Act 2000, (b) the MAD framework passed by the European Parliament in 2003, and (c) the UK FSA rulebook for 2007. The GFC prompted UK authorities to rethink market abuse rules for the future (Edmonds 2016).

EC Decision-Making

As a then-member of the EU, the UK had to comply with the prohibition on monetary financing contained in Article 123(1) of the Treaty on the Functioning of the European Union (TFEU),^FThe TFEU, itself based on the Treaty of Maastricht of 1992, is one of the EU’s two foundational treaties (the other being the Treaty on European Union). It sets out in detail the principles and objectives of the EU and the scope and functional responsibilities of EU institutions (the Treaty on European Union in contrast defines the EU’s purpose and lays out its institutions and form). As a technicality, before the Lisbon Treaty came into effect in 2009, TFEU Article 123 was Article 101 of the Treaty Establishing the European Community, but the content was unchanged when the Lisbon Treaty relocated the article. which reads:

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as “national central banks”) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments. (EU 2009, art. 123)

TFEU Article 123 prohibits the extension of liquidity to insolvent firms (at least without a state guarantee), as such is considered a public undertaking (in other words, one that should be supported with state resources). The monetary financing prohibition—including its application to emergency liquidity—is EU-level law, and thus applies even to those nations that are Member States of the EU but not members of the Eurosystem. For more on the application of the monetary financing prohibition to emergency liquidity assistance, see (V. Arnold 2025).

The European Commission reviewed the aid and determined that the September 14 facilities did not constitute State Aid under Article 87 (1) of the EC Treaty, because the September 14 facilities were initiated by the BoE before any of the other measures for Northern Rock. The October 9 amended facilities and the other government support did qualify as State Aid since the EC assessed that no market economy investor would have granted any of the measures. Yet, the Commission decided that the measures were compatible with the Common Market as rescue aid pursuant to Article 87 (3) (c) of the EC Treaty and raised no objections against them (EC 2007).

Administration of Liquidity Facilities

The BoE granted emergency liquidity to Northern Rock on September 14, 2007. This took the form of a loan facility and a repurchase facility. In order to draw on the facilities, Northern Rock had to post collateral, and the BoE needed to be assured that the FSA viewed Northern Rock as complying with prudential requirements (EC 2007).

In exceptional circumstances, such as a time when the government is considering a support operation, a standing committee comprising the chancellor of the Exchequer (the head of HM Treasury and the government’s chief financial minister), the governor of the BoE, and the chairman of the FSA meets. The BoE and FSA each assess the crisis and its possible financial stability implications and provide separate assessments to the chancellor. In such an event, the primary goal of the authorities is to reduce the risk of wider financial or economic disruption while minimizing moral hazard and financial risk to taxpayers (BoE 2006).

Northern Rock again requested liquidity support from the BoE in October 2007, at which point the BoE amended the facilities and received an indemnity from HM Treasury (BoE 2008c).

The Court of Directors of the BoE (the Court) was responsible for managing BoE affairs excluding monetary policy. The Court did not have sole responsibility for decisions to grant emergency liquidity, but the BoE governor had to consult the Court on such matters. Specifically, the BoE had to consult with the Transactions Committee (TransCo), a three-member committee to be consulted on transactions outside the BoE’s normal operations (BoE 2009; Plenderleith 2012). After the initial emergency liquidity granted to Northern Rock, the BoE created a new structure for future emergency lending, inclusive of establishing TransCo to facilitate consultation with the Court and to help with the need to make decisions quickly (see Summary Evaluation) (Plenderleith 2012).

Created October 1, 2010, UK Asset Resolution Limited was a holding company under HM Treasury that brought together Bradford and Bingley plc and NRAM for resolution. UKFI managed HM Treasury’s shareholding in UKAR (UKAR 2017).

On August 28, 2008, HM Treasury took over administration of the liquidity facilities from the BoE (HMT 2009; UKAR 2021). To this end, HM Treasury refinanced the loan provided by the BoE to Northern Rock—the refinanced amount was GBP 518.5 million lower than the loan provided in the previous year. HM Treasury charged a floating rate to the company and a fixed rate secured against certain high-quality mortgage assets in addition to all land and buildings owned by Northern Rock. HM Treasury received interest on the loan from Northern Rock (HMT 2009).

Recuperating Amounts Drawn on the Liquidity Facilities

HM Treasury approved the sale of NRAM’s assets. UKFI supervised the sale, advised by investment bank Moelis. UKAR led the sale, advised by Credit Suisse in addition to law firm Slaughter and May (NAO 2016).

Per Sections 6 and 9 of the National Audit Act of 1983, the National Audit Office (NAO) wrote multiple reports for the House of Commons on the nationalization of Northern Rock and included information about the liquidity facilities: March 2009, May 2012, and July 2016 (NAO 2009a; NAO 2012; NAO 2016). The EC wrote a State Aid report on the liquidity facilities and the broader intervention (EC 2007). The Treasury Committee of the House of Commons, a standing body, published a report on Northern Rock in January 2008 (House of Commons 2008; UK Parliament 2024).

The BoE Court of Governors also commissioned a report on the central bank’s emergency lending during the GFC. In October 2012, Ian Plenderleith published this report (the Plenderleith report), which contained a review of the emergency liquidity granted to Northern Rock (Plenderleith 2012).

Characterizations and Run

At 8:30pm on September 13, 2008, the BBC reported that Northern Rock had requested and received emergency support from the BoE (BBC 2007; House of Commons 2008).

On September 14, 2007, the BoE issued a joint statement with HM Treasury and the FSA. The press release said the chancellor of the Exchequer authorized the BoE to provide liquidity support to Northern Rock “against appropriate collateral and at an interest rate premium” (BoE 2007c). The release also said the FSA judged that Northern Rock “is solvent, exceeds its regulatory capital requirement, and has a good quality loan book” (BoE 2007c). It described the decision to provide the emergency liquidity as reflecting the difficulties of Northern Rock in accessing longer-term funding and the mortgage securitization market, both markets on which the bank relied. The press release said the BoE, in its role as lender of last resort, was ready to make liquidity facilities available to other institutions facing short-term liquidity issues (BoE 2007c). While the press release did not specify a borrowing limit, Reuters contemporaneously reported that then–Chancellor Darling said that the peak lending amount would be limited by the amount of “good collateral” available in Northern Rock (Reuters 2007c).

On September 18, 2007, Northern Rock said that the “tide has turned” after the announcement of the government’s deposit guarantee (Reuters 2007b).

On September 20, 2007, then–BoE Governor King appeared before parliament and defended central bank actions since the onset of the GFC. Members of parliament probed the discrepancy between (a) King’s criticism of aid granted by the European Central Bank (ECB) and US Federal Reserve to cash–starved banks and (b) the BoE’s emergency lending to Northern Rock. King said, “We have balanced the concerns about moral hazard against the concerns that arose from the beginning of this week about the strains on the banking system more generally” (Dougherty 2007). Governor King also said that the UK’s insufficient deposit insurance system was also to blame for the run on Northern Rock. Considering that Northern Rock could not sell its mortgage-backed securities in tight credit conditions, King said that the BoE had to intervene (Dougherty 2007).

The three agencies issued another joint statement on October 9, 2007, in which HM Treasury made a statement about the guarantee arrangements and said they would be complemented by additional facilities from the BoE. The press release said the arrangements were put in place at the request of Northern Rock and would help the bank pursue a full range of options (BoE 2007a).

Then–BoE Governor King delivered a speech on October 9 in which he discussed Northern Rock and the broader financial system. King said the initial actions from authorities seemed to worsen the situation at Northern Rock rather than stabilize it (BoE 2007b). Similarly, the BoE’s 2007 Financial Stability Report said the announcement confirmed the extent of the difficulties and led to a run on retail deposits (BoE 2007d). King also said the issue at Northern Rock was not inadequate capital but rather its vulnerability to reduced liquidity in the markets for securitized mortgages (BoE 2007b).

Disclosure

King would have preferred to not disclose the emergency liquidity granted to Northern Rock on September 14, but UK and EU laws, including market abuse legislation, required disclosure of such aid (see Key Design Decision No. 3, Legal Authority) (Dougherty 2007; Reuters 2007a).

On October 11, 2007, then–Chancellor Alistair Darling told the House of Commons that the BoE’s facility to Northern Rock had been “replaced” on October 9 (Bowers and Elliott 2007). HM Treasury also made a stock market statement referring to the new arrangement: “In view of the scale and nature of the new facilities, the Treasury has agreed to indemnify the Bank of England should the Bank of England face a deficit having previously made all reasonable endeavors to recover its claims on the company” (Bowers and Elliott 2007).

The BoE did not disclose certain terms such as the end date or interest rate for the liquidity facilities, and the EC did not include the terms in its State Aid report (EC 2007, 3).

The BoE included details of the facilities in its annual report and provided some detail on amounts outstanding in its 2008 accounts (BoE 2008b; BoE 2008c).

The BoE did not specify amounts outstanding in its weekly balance sheet report. The lending to Northern Rock fell under the “Other assets” category without any more granularity. The chancellor said the BoE “does not provide details of any operations because it believes that doing so would undermine its ability to provide such support” (House of Commons 2008). HM Treasury is required to give details of contingent liabilities in its Estimates and Supplementary Estimates report but did not include information about the Northern Rock support in its winter 2007 report published on November 15. When the Treasury Select Committee asked HM Treasury why there was no reference to the contingent liability in the winter report, then–Permanent Secretary to the Treasury Nicholas Macpherson said they would “make a note of the contingent liability in the Spring Supplementary Estimates” (House of Commons 2008). Later in the Spring Supplementary Estimates published in February 2008, HM Treasury said that there was “no need to change the amounts of resources or cash sought” to reflect the impact of Northern Rock (HMT 2008).

For the September 2007 liquidity facilities, then–Chancellor Darling said that the peak lending amount would be limited by the amount of “good collateral” available in Northern Rock (Reuters 2007c).

For the October 2007 liquidity facilities, the BoE did not set a borrowing limit, but the amended facilities were secured against all Northern Rock assets (BoE 2008c; House of Commons 2008). Borrowing would be less than the market value of the collateral due to the haircut policy (EC 2007; House of Commons 2008).

By late October 2007, Northern Rock had drawn about GBP 13 billion–GBP 14 billion from the September 14 facilities. After that point, the Treasury Select Committee said figures relating to the bank’s borrowing from the government appeared to include funds from the amended facilities (House of Commons 2008).

Although the October liquidity facilities were requested and indemnified by HM Treasury, the BoE administered the facilities (EC 2007).

Northern Rock’s annual reports revealed that the amount outstanding on the liquidity facilities reached GBP 28.5 billion as of December 31, 2007 (see Figure 5) (Northern Rock 2008a; 2009; Plenderleith 2012). In the course of the year, the government had recovered GBP 18 billion so that the amount outstanding was GBP 8.9 billion at the end of 2008 (Northern Rock 2009).

Public documents at the time did not disclose the interest rates for the emergency liquidity. Both of the September 14 facilities—the loan and repo facilities—used the same rate set at an unspecified fixed spread over the BoE’s official rate, then 5.75%, and above the BoE’s standing facility’s rate (EC 2007, 3). The September 14 press release said the lending would be at an interest rate premium (BoE 2007c).

The amended facilities beginning in October also charged a rate above the BoE’s official rate 0/0/00 0:00:00 AM. The interest premium under this amended arrangement would ultimately be paid to HM Treasury, as HM Treasury agreed to indemnify the BoE against losses. HM Treasury would cover any deficit existing once the BoE made all reasonable efforts to recover its claims. According to the payment-in-kind (PIK) interest agreement, the interest—on the other facilities and the PIK facility itself—was rolled up for five years and subordinated as Tier 2 debt, a lower status than the “senior secured creditor” status applied to the BoE’s broader support (EC 2007; House of Commons 2008).

According to later annual reports by UKAR, Northern Rock’s interest rate was the BoE base rate plus 25 basis points (bps). On May 4, 2012, the interest rate increased to the BoE base rate plus 100 bps (UKAR 2014; UKAR 2017).

Additionally, Northern Rock paid a fee for the extension of the liquidity facilities such that Northern Rock did not have a commercial advantage (BoE 2007a).

The emergency liquidity granted on September 14, 2007, had a predetermined but not disclosed repayment date. The facilities were also repayable on demand. The amended facilities also had an undisclosed final repayment date (EC 2007). In its March 2008 restructuring plan, Northern Rock said that it expected to repay 25% of its emergency liquidity by 2008, 75% of its emergency liquidity by 2009, and 100% of its emergency liquidity by 2010—excluding open market repo arrangements (Northern Rock 2008b). Meanwhile, in a 2012 report, the NAO said that authorities had expected the emergency liquidity to be repaid by the middle of 2010 and the guarantee to expire by the end of 2011 (NAO 2012).

In its 2007 annual report, Northern Rock listed its primary objectives as the repayment of the BoE debt, the release of the guarantee arrangements from HM Treasury, and a successful return to the private sector (Northern Rock 2008a).

In February 2008, HM Treasury nationalized Northern Rock and said it viewed that path as the best chance to protect the GBP 51 billion in public loans and guarantees (House of Commons Public Accounts Committee 2009). This action required the Banking (Special Provisions) Bill, as no existing legislation would allow the government to take over the bank (NAO 2009a; Northern Rock 2009).

Net of liquidity deposits held at the BoE,^FThe authors interpret this to mean Northern Rock’s reserves at the BoE resulting from the liquidity facility (Northern Rock 2009). Northern Rock repaid GBP 18 billion of the loan during 2008 leaving approximately GBP 8.9 billion outstanding at the end of the year. On a gross basis, GBP 15.6 billion was still outstanding. This was a faster pace of repayment than was planned (Northern Rock 2009).

After nationalizing the bank, the government split Northern Rock into good and bad banks, Northern Rock and NRAM, respectively. HM Treasury then sold Northern Rock back to the private sector while NRAM was responsible for the debt owed to the government (Plenderleith 2012). Over the subsequent years, HM Treasury sold off many of Northern Rock’s assets to recuperate the government-provided funding (M. Arnold 2017). On April 24, 2019, UKAR fully repaid the outstanding amount on the liquidity facilities (UKAR 2019).

Draws on the September 14 loan facility were collateralized by unsecuritized residential mortgage loans; the repo facility could use various securities. Northern Rock reported that it had funded GBP 4.6 billion in newly issued Granite mortgage-backed securities, and its outstanding repo loan was GBP 3.6 billion (EC 2007; Northern Rock 2008a). The BoE applied haircuts to the collateral in both facilities to protect itself against drops in market value (EC 2007; Northern Rock 2008a). The BoE valued the collateral daily and used the same methodology as in its normal monetary operations (EC 2007). The BoE governor described the collateral as “name-specific” (House of Commons 2008).

On October 9, 2007, HM Treasury requested that the BoE make additional facilities available to Northern Rock. HM Treasury indemnified the BoE against losses arising from the amended arrangement and covering losses only after October 9 (EC 2007). Then–BoE Governor Mervyn King described collateral for the updated facilities as all the assets of Northern Rock, “right down to the paper clips,” and noted that HM Treasury was the entity bearing the risk because of the indemnity (House of Commons 2008). The interest premium would go to HM Treasury and was rolled up for five years and subordinated as Tier 2 debt (EC 2007; House of Commons 2008). However, the chancellor of the Exchequer said the liability for the interest rate premium was “a small amount of money” (House of Commons 2008).

Discussing the security of the BoE’s lending, the chancellor said the BoE was Northern Rock’s senior secured creditor. The chancellor said the September 14 facilities were secured by assets including high-quality mortgages with significant haircuts and high-quality securities with the highest credit rating (House of Commons 2008).

No information is available regarding monetary policy transmission connected to the liquidity facilities.

Northern Rock’s then–Senior Independent Director Ian Gibson asked each board member to agree to resign conditionally, and all agreed. However, the board members did not immediately resign because Northern Rock stakeholders wanted the current management to guide the bank during the immediate crisis (House of Commons 2008; Slater 2007). Northern Rock’s chairman announced his resignation on October 19, 2007. Four nonexecutive directors retired on November 16, and three other directors stepped down from the board but stayed at the company. On December 13, 2007, Northern Rock’s chief executive stepped down. The chairman of the Risk Committee departed as well (House of Commons 2008).

The UK Treasury Select Committee report said the directors of Northern Rock were the “principal authors” of the problems the bank faced since August 2007 and that it was right for them to be replaced (House of Commons 2008).

Under the terms of the loans from the BoE, Northern Rock had to conserve cash and reduce the number of mortgages it wrote. The bank needed to get BoE approval before entering into corporate restructuring, making substantial changes to its business, or paying dividends. The BoE monitored compliance with this stabilization plan and had increased access to information (NAO 2009a).

While not directly tied to the emergency liquidity, the EC decided that the guarantee arrangements from HM Treasury could remain in place for only six months unless HM Treasury submitted a restructuring or liquidation plan by March 2008 (NAO 2009a).

In testimony to the TSC, Northern Rock employees said that the government support did not come with any particular governance conditions but that the FSA and other tripartite authorities were closely overseeing the bank’s activities. In mid-September, the chairman of Northern Rock said the board had listened to the FSA and others and decided not to pay a shareholder dividend that had been announced in July (House of Commons 2008).

On April 30, 2008, the BoE amended the loan facilities again to incorporate a new liquidity management framework for managing funding and liquidity requirements (BoE 2008b; Northern Rock 2009). Per the framework, cash flows were used to pay wholesale funding maturities, maintain adequate liquidity to meet outflows, and repay the emergency facilities—in that order. Any permanent surplus liquidity had to go toward the repayment of the government-provided facilities. New lending to customers had to come from new retail or wholesale funding (Northern Rock 2009).