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more northern rock October 9, 2007

Posted by Bradley in : Uncategorized , trackback

Today the UK Treasury, FSA and Bank of England announced:

HM Treasury, on behalf of the Tripartite Authorities, can today confirm that the guarantee arrangements previously announced to protect existing depositors of Northern Rock plc will be extended to all new retail deposits made after 19 September, including those made from today. These arrangements will cover all retail deposits, including future interest payments, movements of funds between accounts and term deposits for the duration of their term.

New Northern Rock depositors appear to be in a better position than depositors in other institutions (now protected up to £35,000). The announcement states that Northern Rock will pay a fee for this arrangement so that it will not receive a commercial advantage over other institutions, but there are no details. The general approach is to say that regulation cannot and should not prevent firms from failing. See, for example this statement from the FSA’s annual report for 2006-7:

We accept that we cannot achieve, and that it would be counterproductive to pursue, a zero-failure approach. Investment involves risk, and risk entails occasional failure.

Except when it doesn’t.

The FSA published a memorandum to the Treasury Select Committee in which it acknowledges its failure to predict in advance the dramatic deterioration in market conditions which precipitated Northern Rock’s crisis. And the FSA recognises the need for more discussion about depositor and investor protection.

The [Financial Services Compensation Scheme]’s main function is consumer protection: it provides consumers with a measure of compensation in the event of failure of an institution in the financial sector. The existence of a compensation scheme helps to reduce the systemic risk that a single failure of a financial firm may trigger a wider loss of confidence. But while it contributes to encouraging consumer confidence in the markets, the FSCS was not designed, on its own, to be able to deal with all potential failures of financial firms, nor to be a crisis management tool in the event of a largescale failure.

So is Northern Rock an exceptional case, a situation where stepping in now to support confidence can protect other firms, or is it something more?

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