LOLR is the term used for the government or the central bank of a country. It plays the role of a lender when no other source is open to a borrower. Who is this borrower so gracious that LOLR will always be available to it? This is a dilemma faced by many when they see LOLR stepping in to protect a run on deposits of large financial institutions. This question has come to haunt once again when the latest casualty of infamous sub-prime crisis, Northern Rock Plc., has been provided a lifeline by LOLR.
Northern Rock is the largest mortgage lender in UK. The model Northern Rock operated on was such that its mortgage lending was almost four times its customer deposits. Northern Rock largely depended on its ability to package its mortgage loans and sell to investors. Also it relied heavily on short term loans from the inter-bank markets. However, in August, BNP Paribas suspended withdrawal from its investment funds targeting such mortgage backed securities. The reason given by BNP was that there was no clarity on valuation of investments made by these funds. This caused banks across Europe to become wary of their counterparties in the inter-bank loan markets. At this time Northern Rock started to feel the pinch of credit squeeze. Finally, in September Northern Rock initiated talks with the Bank of England (UK Central Bank) when it realized that inter-bank loans market is not going to improve.
LOLR is supposed to keep the financial system of country in tact. At the same time it is responsible for maintaining the investor and depositor confidence in LOLR’s ability. Across the world, be it Federal Reserve or European Central Bank or Reserve Bank of India, LOLR indulge in open market operations (OMO) when they feel excess liquidity or credit crunch is hurting the economy. The prime target of these LOLR is the inter-bank market which is also called call money market. However, the Bank of England has shied away from indulging in any kind of measures to ease the liquidity in inter-bank market. The reason given by the Bank is that it is not there to protect investors but rather to protect the interest of depositors. Certainly Bank of England has succeeded in both its aims as the Northern Rock stock has fallen by almost 60% and all its depositors have been protected by the credit line provided by LOLR. But it remains to be seen how much Bank of England has done to maintain depositor and investor confidence in its abilities.
Northern Rock is the largest mortgage lender in UK. The model Northern Rock operated on was such that its mortgage lending was almost four times its customer deposits. Northern Rock largely depended on its ability to package its mortgage loans and sell to investors. Also it relied heavily on short term loans from the inter-bank markets. However, in August, BNP Paribas suspended withdrawal from its investment funds targeting such mortgage backed securities. The reason given by BNP was that there was no clarity on valuation of investments made by these funds. This caused banks across Europe to become wary of their counterparties in the inter-bank loan markets. At this time Northern Rock started to feel the pinch of credit squeeze. Finally, in September Northern Rock initiated talks with the Bank of England (UK Central Bank) when it realized that inter-bank loans market is not going to improve.
LOLR is supposed to keep the financial system of country in tact. At the same time it is responsible for maintaining the investor and depositor confidence in LOLR’s ability. Across the world, be it Federal Reserve or European Central Bank or Reserve Bank of India, LOLR indulge in open market operations (OMO) when they feel excess liquidity or credit crunch is hurting the economy. The prime target of these LOLR is the inter-bank market which is also called call money market. However, the Bank of England has shied away from indulging in any kind of measures to ease the liquidity in inter-bank market. The reason given by the Bank is that it is not there to protect investors but rather to protect the interest of depositors. Certainly Bank of England has succeeded in both its aims as the Northern Rock stock has fallen by almost 60% and all its depositors have been protected by the credit line provided by LOLR. But it remains to be seen how much Bank of England has done to maintain depositor and investor confidence in its abilities.
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