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Reflections on Northern Rock: The Bank Run That Heralded the Global Financial Crisis

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  • Hyun Song Shin
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    Abstract

    The U.K. bank Northern Rock became the first high-profile casualty of the global financial crisis of 2007-2008 when it suffered its depositor run in September 2007. In spite of the television images of long lines of depositors outside its branch offices, the run on Northern Rock was unlike the textbook retail depositor run caused by coordination failure. Also, contrary to received wisdom, its reliance on securitization was not an immediate factor in its failure. Rather, its problems stemmed from its high leverage coupled with reliance on institutional investors for short-term funding. When the de-leveraging in the credit markets began in August 2007, Northern Rock was uniquely vulnerable to the shrinking of lender balance sheets arising from the tick-up in measured risks. Financial regulation that relies on risk-weighted capital requirements is powerless against such runs. The Northern Rock case also offers lessons concerning the economics of short-term debt.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.23.1.101
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    Bibliographic Info

    Article provided by American Economic Association in its journal Journal of Economic Perspectives.

    Volume (Year): 23 (2009)
    Issue (Month): 1 (Winter)
    Pages: 101-19

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    Handle: RePEc:aea:jecper:v:23:y:2009:i:1:p:101-19

    Note: DOI: 10.1257/jep.23.1.101
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    1. Douglas W. Diamond & Raghuram G. Rajan, . "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," CRSP working papers 476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    2. Brunnermeier, Markus K & Pedersen, Lasse Heje, 2007. "Market Liquidity and Funding Liquidity," CEPR Discussion Papers 6179, C.E.P.R. Discussion Papers.
    3. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
    4. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    5. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
    6. David G. Mayes & Geoffrey Wood, 2008. "Lessons from the Northern Rock Episode," Economie Internationale, CEPII research center, issue 114, pages 5-27.
    7. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    8. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
    9. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
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