A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Milne, Alistair; Wood, Geoffrey Working Paper Shattered on the rock? British financial stability from 1866 to 2007 Bank of Finland Research Discussion Papers, No. 30/2008 Provided in Cooperation with: Bank of Finland, Helsinki Suggested Citation: Milne, Alistair; Wood, Geoffrey (2008) : Shattered on the rock? British financial stability from 1866 to 2007, Bank of Finland Research Discussion Papers, No. 30/2008, ISBN 978-952-462-481-7, Bank of Finland, Helsinki, http://nbn-resolving.de/urn:NBN:fi:bof-20140807586 This Version is available at: http://hdl.handle.net/10419/212121 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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British financial stability from 1866 to 2007 Bank of Finland Research Discussion Papers 30 • 2008 Suomen Pankki Bank of Finland PO Box 160 FI-00101 HELSINKI Finland +358 10 8311 http://www.bof.fi Bank of Finland Research Discussion Papers 30 • 2008 Alistair Milne* – Geoffrey Wood** Shattered on the Rock? British financial stability from 1866 to 2007 The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Bank of Finland. * E-mail: [email protected]. Corresponding author. ** Reader in Economics and Professor of Economics respectively, Cass Business School London. We are greatly indebted to Josephine Fogden for her excellent research assistance, and to David Mayes, Anna Schwartz, and the participants in the memorial conference in honour of Ted Balbach at the Federal Reserve Bank of St. Louis on 3 March 2008 for their comments and questions. http://www.bof.fi ISBN 978-952-462-480-0 ISSN 0785-3572 (print) ISBN 978-952-462-481-7 ISSN 1456-6184 (online) Helsinki 2008 Shattered on the Rock? British financial stability from 1866 to 2007 Bank of Finland Research Discussion Papers 30/2008 Alistair Milne – Geoffrey Wood Monetary Policy and Research Department Abstract In autumn of 2007 Britain experienced its first bank run of any significance since the reign of Queen Victoria. The run was on a bank called Northern Rock. This was extraordinary, for Britain had been free of such episodes because by early in the third quarter of the 19th century the Bank of England had developed techniques to prevent them. A second extraordinary aspect of the affair was that it was the decision to provide support for the troubled institution that triggered the run. And thirdly, unlike most runs in banking history, it was a run only on that one institution. This paper considers why the traditional techniques for the maintenance of banking stability failed – if they did fail – and then considers how these techniques may need to be changed or supplemented to prevent such problems in the future. The paper starts with a narrative of the events, then turns to banking policy before the event and to the policy responses after it. We suggest both why the decision to provide support triggered the run and why the run was confined to a single institution. That prepares the way for our consideration of what should be done to help prevent the recurrence of such episodes in the future. Keywords: bank failure, lender of last resort, money markets, bank regulation JEL classification numbers: E42, E58, N24 3 Northern Rockista rahoitusvalvonnan kompastuskivi? Rahoitusmarkkinoiden vakaus Isossa-Britanniassa vuoden 1866 jälkeen Suomen Pankin keskustelualoitteita 30/2008 Alistair Milne – Geoffrey Wood Rahapolitiikka- ja tutkimusosasto Tiivistelmä Syksyllä 2007 Iso-Britannia koki ensimmäisen merkittävän talletuspaon sitten kuningatar Viktorian valtakauden. Talletuspaon kohteeksi joutui Northern Rock. Kyseessä oli harvinainen tapahtuma, koska Iso-Britannia oli onnistunut välttämään tällaiset kriisit Englannin keskuspankin 1800-luvun kolmannella neljänneksellä kehittämien järjestelmien ansiosta. Kriisissä oli harvinaista myös se, että sen laukaisi päätös tukea vaikeuksiin joutunutta rahoituslaitosta. Lisäksi kriisi poikkesi pankkikriisien historiasta siten, että tällä kertaa pankkipaon kohteeksi joutui vain yksi rahoituslaitos. Tässä tutkimuksessa selvitetään, miksi perinteiset kriisienhallintajärjestelmät eivät tämänkertaisen kriisin yhteydessä toimineet, jos näin voidaan ylipäätään väittää, ja miten näitä järjestelmiä tulisi muuttaa tai kehittää kriisien ehkäisemiseksi tulevaisuudessa. Työssä käydään ensi läpi kriisin keskeiset vaiheet, ja sen jälkeen huomio kiinnitetään pankkivalvontaan kriisiä edeltävänä aikana sekä viranomaistoimiin kriisin puhkeamisen jälkeen. Työssä yritetään perustella, miksi päätös tukea ongelmapankkia laukaisi kriisin ja miksi kriisi ei levinnyt muihin rahoituslaitoksiin. Näiden tulkintojen pohjalta työssä tarkastellaan lopuksi ehdotuksia politiikkatoimenpiteiksi, joiden käyttö helpottaisi vastaavien kriisien ehkäisemistä tulevaisuudessa. Avainsanat: pankin konkurssi, hätärahoittaja, rahamarkkinat, pankkisääntely JEL-luokittelu: E42, E58, N24 4 Contents Abstract .................................................................................................................... 3 Tiivistelmä (abstract in Finnish) .............................................................................. 4 1 Introduction ...................................................................................................... 7 2 What happened? Description and chronology .............................................. 8 3 The Bank of England’s money market operations ...................................... 16 4 The regulatory structure ............................................................................... 17 5 Regulation in the run up to crisis .................................................................. 18 6 Another autumn crisis ................................................................................... 21 7 Did the Bank of England provide sufficient liquidity assistance to the money markets? ................................................................................... 23 8 A safe haven? .................................................................................................. 26 9 The support operation ................................................................................... 29 10 Was this a lender of last resort operation? .................................................. 36 11 Why did the authorities provide support at all? ......................................... 40 12 An interpretation ............................................................................................ 41 13 Borrowing via the standing facility .............................................................. 42 14 Interbank linkages ......................................................................................... 43 15 Retail depositors ............................................................................................. 44 16 What can be done? ......................................................................................... 44 17 Conclusions ..................................................................................................... 50 References .............................................................................................................. 52 Appendix 1 ............................................................................................................. 57 Appendix 2 ............................................................................................................. 60 Appendix 3 ............................................................................................................. 62 Appendix 4 ............................................................................................................. 63 5 6 1 Introduction In the Autumn of 2007 Britain experienced its first bank run of any significance since the reign of Queen Victoria.1 The run was on a bank called Northern Rock. This was an extraordinary event, and the lapse of time since its immediate predecessor is the least extraordinary aspect of it. For Britain had been free of such episodes not by accident, but because by early in the third quarter of the 19th century the Bank of England had developed techniques to prevent them. These techniques had been used, in Britain and elsewhere, had worked, and appeared to be trusted. A second extraordinary aspect of the affair was that it was the decision to provide support for the troubled