Northern Rock proposes split

Northern Rock has proposed dividing itself into two separate entities, BankCo and AssetCo, in the second half of this year.

The BankCo entity, Northern Rock proposes in a statement, will take deposits and undertake new lending.

It will hold the retail deposit book and some wholesale deposits, together with a proportion of Northern Rock’s unencumbered mortgage assets. BankCo will also reconcile Northern Rock’s branches and mortgage origination capability.

AssetCo will hold the balance of the existing residential mortgage book. This will include the interest in those mortgages allocated to the granite securitisation and covered bond programmes.

Furthermore, AssetCo is to hold the existing government loan to Northern Rock, plus the wholesale funding instruments. According to the statement, the entity will not hold any retail deposits and will be regulated as a mortgage lender with a lower regulatory requirement.

Northern Rock, which was rescued from collapse in 2007 and nationalised in early 2008, says it will need additional capital of no more than £3 billion.

“The financial crisis, particularly the failure of Northern Rock, exposed a number of weaknesses in the policy and legal framework for crisis management and resolution,” the Organisation for Economic Co-operation and Development (OECD) notes in its economic survey for Britain published today.

It quotes an internal document by the Financial Services Authority (FSA) which highlights “a range of serious failings in the supervision of Northern Rock”. Northern Rock, according to this FSA report, had one of the longest regulatory periods between formal assessments, and the lowest number of close and continuous regular surveillance meetings.

Its supervision had also been hindered by Northern Rock being moved between FSA divisions three times, the report continues. Supervisory resources in the years prior to the crisis were diverted by takeovers, demutualisation, and the implementation of Basel 2.

The FSA report says that the division mainly responsible had cut staff and that records of supervisory meetings were often not kept.

“Even as late as spring 2007, Northern Rock was allowed to pay a large dividend and reduce its capital adequacy target. This was only months before it failed and at a time when the FSA was already concerned about its liquidity.”

According to the OECD report, the FSA had regulatory responsibilities while the Bank of England was the lender of last resort. “However, no instruments to take control of a failing bank exisited,” the OECD says.

In its economic survey, the OECD presses for tougher regulation and supervision of British banks to achieve financial stability.

Prior to the announcement of splitting Northern Rock into two entities, the bank had proposed several changes in its business strategy. This included a slower rate of mortgage redemptions. Mortgage lending is to increase to £5 billion in 2009 and up to £14 billion over the next two years. It also proposed a change in the repayment profile of the government loan, to reflect the new mortgage lending and slowing redemption.

The implementation of Northern Rock’s proposed restructuring plan has to be approved by the European Commission and on any necessary consents and approvals under foreign law.

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