London move to safeguard UK savings

By Peter Thal Larsen and Chris Giles in London

Published: September 17 2007 23:02 | Last updated: September 17 2007 23:02

The British government on Monday night stepped in to guarantee the savings of customers of the beleaguered Northern Rock bank as it moved to prevent panic from gripping the entire UK banking sector.

Alistair Darling, chancellor of the exchequer, pledged the government would fully guarantee people's savings and the Treasury said similar assurances would be available to customers of any other lender that ran into difficulty in the current turmoil.

Customers queued in their thousands to withdraw money from the mortgage lender for a third day and the stock market showed signs of fear spreading to other banks.

The government's move, which goes far beyond the current scheme for protecting depositors, came amid signs that the crisis of confidence in Northern Rock was spreading to other lenders. Shares in Alliance & Leicester, Britain's eighth-biggest bank, plunged more than 30 per cent after fears – denied by the bank – that it had been forced to follow Northern Rock in calling on the Bank of England for support.

Bank stocks across Europe were also hit by concerns that higher interest rates could undermine buoyant property markets that have been the source of much of the banks' loan books.

The cost of borrowing funds overnight in the sterling market surged to its highest level for six years – or since the terrorist attack on the World Trade Center – as the growing problems at Northern Rock sparked a new sense of distrust between banks.

Money market traders said the cost of borrowing funds overnight temporarily touched 6.5 per cent, compared with a level around 5.75 per cent, close to the base rate, where these funds had been trading late last week.

Mr Darling said the government's action meant "people can continue to take their money out of Northern Rock. But if they choose to leave their money in Northern Rock, it will be guaranteed safe and secure".

The bank on Monday night said the guarantee should remove any doubts among customers.

The opposition Conservative party backed the government's guarantee. George Osborne, shadow chancellor, said the "gravity of the situation" justified the move, adding that he hoped it would reassure savers.

The government move is a belated recognition that last week's rescue of Northern Rock by the Bank of England has failed. In spite of repeated assurances from the chancellor and the Financial Services Authority, the UK regulator, customers rushed to withdraw savings amid worries the lender would fail.

Regulators are concerned that the approach for compensating bank customers is not robust enough to prevent them from rushing to withdraw their cash. Under the scheme, the government guarantees all deposits below £2,000 ($4,000) and 90 per cent of sums up to £35,000.

The British system does not make any special provision for handling banks that become insolvent. This contrasts with other countries, such as the US and Canada, where regulators have the authority to transfer deposits to other lenders if they believe a bank could fail.

Regulators support a takeover of Northern Rock. The bank said it was not in talks, but was "actively considering all options in the interests of shareholders, customers and other stakeholders". Its shares yesterday plunged a further 35 per cent.