Commercial banks have significant functions in every economy. This paper first critically examines the roles of commercial banks. It then analyses the crisis of Northern Rock Bank, in relation to the roles of the commercial banks. Prior to the actual analysis of the case of the Northern Rock bank is a brief background that elaborates the scenario of the Northern Rock Bank Crisis. The paper then ends with a summary that highlights the key points discusses.
Roles of Commercial Banks
The roles of commercial banks are separated into two groups including primary roles and secondary roles (Hon, 2008). The primary roles of a commercial bank involve granting advances and loans and receiving deposits. A key, significant action of a commercial bank is to collect deposits from the civic. Individuals who hold extra savings and income find it suitable to deposit the sums with banks. Money deposited with the bank normally makes interest, depending on the nature of deposits (Shleifer and Vishny, 1992). Therefore, deposits with the bank develop alongside the interest made. In case the rate of interest is towering, public are motivated to deposit extra money with the bank. The bank also provides security on deposited funds. Another vital role of a commercial bank is to offer advances and loans. These advances and loans are offered to members of the civic and to the business society at a higher interest rate than permitted by banks on a range of deposit accounts. Interest rates associated with advances and loans differ depending on the function, phase and the form of reimbursement. The chief source of a bank’s revenue is the difference involving the rate charged on loans and rate of interest permitted on deposits.
Loans are offered for an exact time phase. Habitually, commercial banks offer short-term loans. However, other loans that last for about one year, term loans, can also be offered. The person being financed can extract the amount in installments or lump sum. Nevertheless, interest is determined on the whole sum of the loan. Loans are usually offered against the security of definite material goods. It is possible to repay in either installments or a lump sum.
Banks offer advices, which are credit facilities presented to clients (Saunders, 1996). Advances differ from loan in the logic that loans may be established for long phases, but advances are usually offered for a short phase. Besides, the function of offering advances is to satisfy the daily necessities of business. Interest rates associated with advances differ from one bank to the other. Interest is normally indicted on the sum withdrawn and not on the endorsed quantity. Overdraft, bill discounting and cash credit are among the ways in which banks grants short-term monetary aid. Cash credit refers to a deal in which the bank lets a client draw sums up to a precise bound (Diamond and Dybvig, 1983). The quantity is credited to the client’s account. The client can remove this sum when and as he wants. Interest is normally indicted on the quantity taken. Cash Credit is offered as indicated by established terms conditions and terms with the clients (Hon, 2008). Another credit facility presented by banks is overdraft. A client who boasts a current account with the bank can take away more than the sum of credit balance that he has in the bank account. It is usually a provisional structure. Overdraft flair with a precise limit is acceptable either on the security of property, or on individual security. Banks offer short-term money through making payment of the sum prior to the due time of the bills following subtraction of a definite rate of discount (Calomiris and Kahn, 1991; Shleifer and Vishny, 1997). The involved member acquires the funds devoid of waiting for the time of the bills’ maturity. If any bill is desecrated on the payable date, the bank may recover the quantity from the client. In addition, the primary roles of receiving deposits and providing money on loans, banks execute several other tasks, which are referred to as secondary roles (Hon, 2008). These tasks are explained below.
- Undertaking secures keeping of treasures, securities and vital credentials by offering safe deposit lockers.
- Giving letters of circular notes, travelers’ cheques and credits.
- Transporting funds from one subdivision to another area office of the bank and from one region to another.
- Offering clients services of foreign exchange.
- Presenting information on the credit value of clients.
- Standing warranty on behalf of its clients, for making costs for obtaining commodities, vehicles and equipment.
- Giving pay orders and demand drafts.
- Gathering and providing business knowledge.
There exists several differences involving primary and secondary roles of Commercial Banks. First, whereas primary roles are the key actions of the bank, secondary roles are the lesser actions of the bank. Second, primary functions are the key foundations of a bank’s income, whereas secondary roles are not the key foundations. Third, primary roles are required, on the component of the bank, to execute while secondary roles are not mandatory on the piece of the bank to complete. However, all commercial banks execute these actions.
Background of the Collapse of Northern Rock Bank
Northern Rock existed as a jointly owned mortgage and savings bank, also known as a building society, pending its resolution to go join the stock market in 1997 (Song, 2008). Similar to other building societies in UK, Northern Rock originated from the cooperative groups of the19th century. It was instigated out of the amalgamation of the Rock Building Society and Northern Counties Permanent Building Society.
Still, its identity, “Northern Rock” fabricated associations of sour solidity, which appeared suitable for a mortgage and savings bank (Song, 2008). Like other building societies in the UK, Northern Rock began existence as a regionally founded organization, serving its home customers. Northern Rock was initially located in the northeast of England, near Newcastle. Despite its reserved genesis, Northern Rock had lofty aspirations.
Since June 1998, the initial year following demutualization, to June 2007, when it experienced catastrophe, Northern Rock’s whole assets developed to 113.5 billion pounds from 17.4 billion pounds (Song, 2008; Milne and Wood, 2008). This expansion in assets matches to a stable, equivalent yearly rate of 23.2 percent, an extremely swift rate of development. By June 2007, Northern Rock was the fifth-biggest bank in the UK through mortgage property. Its success represented the revival of the northeast area following the fall of conventional industries, for instance, shipbuilding and coal mining (Brunnermeier and Pedersen, 2009). Northern Rock supported a significantly noticeable charitable trust and grew to be the chief sponsor of Newcastle United, a local soccer club. Owing to these rationales, Northern Rock ordered severe loyalty in its area base. Nevertheless, as Northern Rock extended its mortgage possessions, the volume of its balance sheet far surpassed its conventional grant stand of branch-founded retail deposits (Greenlaw, 2008). While sum assets rose by a factor of 6.5 during this era, retail deposits merely developed to 24 billion pounds from 10.4 billion pounds (Song, 2008). In 1998, retail subsidy was 60 percent of the bank’s charges, although it fell to 23 percent of entire liabilities in June 2007, at the beginning of the catastrophe, and fell much beyond following the run (Bank of England, 2008). Yet in the instance of retail deposits, just a minute fraction comprised the conventional branch-founded deposits. The volume of the retail deposits, on the occasion of its run, was non-branch-founded deposits, for instance, telephone and postal accounts. Postal accounts necessitate clients to convey their deposits or withdrawal desires through the mail, and clients are rewarded for their bother with a vaguely elevated deposit interest price. Telephone accounts function in an analogous manner, although through telephone (Dudley, 2008; Gromb and Vayanos, 2002). Such non-branch retail deposits allowed Northern Rock to develop their retail deposits away from their constricted area base. However, the deposits attested most susceptible to withdrawal in the outcome of the run on the bank (Guat, 2008). The opening in funding amid the quantity lent out, and the sum depositors’ submitted was fabricated by securitized remarks, and other nonretail subsidies, for instance, covered bonds and interbank deposits (Kashyap, 2008). Covered bonds refer to long-term charges documented against isolated mortgage possessions. Since they were long-term and illiquid in nature, they were not openly drawn in the run. Nevertheless, further short-run wholesale subsidy was intimately concerned in the run on the bank.
A Critical Analysis of the Collapse of Northern Rock Bank
During September 2007, weekly readers and TV viewers in the world observed pictures of what appeared like a conventional bank run, to be precise, depositors lingering in queues remote the branch offices of Northern Rock, a United Kingdom bank, to remove their money (Song, 2008). The earlier U.K. bank run, prior to Northern Rock, occurred in 1866 at a London bank that overstretched itself in the docks boom and the railway of the 1860s, known as Overend Gurney (Dudley, 2007; Yorulmazer, 2008). Since 1930’s bank runs were popular in the United States, although they vanished with the creation of deposit insurance supported by the Federal Deposit Insurance Corporation (Bryant, 1980). Conversely, in the United Kingdom, deposit insurance is a limited event of the banking trade and covers just a fraction of the deposits. U.K. bank deposits were entirely covered up to 2,000 pounds during the happening of the run (Song, 2008). As a result of the run, the motivation to remove one’s deposits from a U.K. bank was thus extremely strong.
In favor of economists, the run on Northern Rock initially appeared to present a rare chance, to learn, at close stations, all the basics implicated in their hypothetical models of bank runs (Dimsdale, 2008; The Economist, 2007). Nevertheless, the action of the Northern Rock bank run failed to fit the usual description.
The BBC’s sunset television news, on September 13, 2007, relay the bulletins that Northern Rock had wanted the Bank of England’s grants (Adrian and Song, 2008b). The following dawn, the Bank of England declared that it would offer urgent liquidity grants. It was, just after the declaration of the central bank, to support Northern Rock that retail depositor’s begun lining outside the branch headquarters.
The retail depositors of the bank led to the fiscal hurt of the bank prior to the run (Mayes and Wood, 2008). Among the U.K. mortgage banks, Northern Rock was remarkable for its profound dependence on nonretail grant. During the 2007 summer, merely 23 percent of its charges were in the shape of retail deposits. Most of its subsidy came from a blend of securitized notes, interim borrowing in the capital markets and other long-term grant springs.
Certainly, the worldwide credit catastrophe first blew up in summer 2007. The interbank lending and the short-term grant market all froze on August 9, 2007. The prompting event on that date was the reports that BNP Paribas, a French bank, was terminating three investment mediums, which donated to U.S. subprime credit property by means of short-term borrowed funds. However, several financial establishments and investment mediums that tapped short-term funding had previously begun encountering intricacies in restoring their short-term borrowing.
While Northern Rock had almost no subprime loaning, it was yet fishing from the identical pool of short-term grant. On August 13, 2007, the administrators of Northern Rock told its controllers at the Financial Services Authority (FSA) of Northern Rock’s grant tribulations. On August 14, the Bank of England was also told about the same. Since that moment and for a whole month pending the critical declaration on September 14, which prompted the run by the depositor, the Bank of England and FSA attempted to resolute the catastrophe at the back of the scenes, possibly by organizing a conquest by a different U.K. bank (Morris and Shin, 2008; Santomero, 1995). Nevertheless, the unfolding credit catastrophe and the reluctance to devote public funds to aid a takeover muffled these endeavors. Having declined to get a purchaser for Northern Rock, the civic declaration on September 14, 2007, by the Bank of England, was an acknowledgment that Northern Rock’s quandary had got to the point where just central bank backing could evade the collapse.
Despite the drama screens and newspaper, the Northern Rock depositor run was an occasion as a result of the liquidity catastrophe at Northern Rock (Bank for International Settlements, 2008). Hence, it was not the happening that prompted liquidity catastrophe at Northern Banks. In this logic, the Northern Rock incident was not a traditional bank run of the type we observe in movies. In fact, the paradox of the descriptions of Northern Rock’s retail clients queuing to remove deposits is that retail deposit grant is conceivably the most established form of grant accessible to a bank (Adrian and Song, 2008a). While retail deposits can be removed on order, bankers have been perceived to yarn that a depositor is more apt to get detached than to change banks.
Therefore, the query poised by the Northern Rock incident is not why retail depositors have a tendency to lose assurance that outcome bank runs, but rather why the abundant short-term grant that Northern Rock benefited from prior to August 2007 swiftly desiccated. The concern is why lenders who control the capital markets opt to refuse to lend swiftly to a bank that had almost no principal lending, and a solid asset book. Northern Rock was in the dealing of primary mortgage loaning to U.K. homes. The asset value of every mortgage bank is susceptible to a turn down in increasing joblessness and house charges.
In conclusion, commercial banks roles can be separated into two groups including primary roles and secondary roles. The primary roles of a commercial bank involve granting advances and loans and receiving deposits. These advances and loans are offered to members of the civic and to the business society at a higher interest rate than permitted by banks on a range of deposit accounts. Interest rates associated with advances ad loans differ depending on the function, phase and the form of reimbursement. In addition, the primary roles of receiving deposits and providing money on loans, banks execute several other tasks, which are referred to as secondary roles. Some of these roles include secure keeping of treasures, transporting funds from one region to another and giving pay orders. However, it is pertinent to note that key differences exist between the primary and secondary roles of a commercial bank.. First, whereas primary roles are the key actions of the bank, secondary roles are the lesser actions of the bank. Second, primary functions are the key foundations of banks income, whereas secondary roles are not the key foundations. Third, primary roles are required to execute while secondary roles are not mandatory on the piece of the bank to complete.
The Northern Rock bank crisis of September 2007 was characterized by depositors lingering in queues remote the branch offices of Northern Rock, to remove their money. As Northern Rock extended its mortgage possessions, the volume of its balance sheet far surpassed its conventional grant stand of branch-founded retail deposits. Most of its subsidy came from a blend of securitized notes, interim borrowing in the capital markets and other long-term grant springs. While Northern Rock had almost no subprime loaning, it was yet fishing from the identical pool of short-term grant. The Case of Northern Rock explains why lenders who control the capital markets opt to refuse to lend swiftly to a bank that had almost no subprime lending, and a solid asset book.
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