This paper seeks to analyse reasons behind the difficulties faced by Northern Rock (NR) and the UK financial system and proposes a return to a more traditional/prudent banking business model, based on a sound balance between sources and uses of funds.
The paper outlines the background to the credit crunch and presents a simple model of a bank and NR's business model. Conclusions and implications are drawn.
It is suggested that credit rating agencies should provide a better assessment of the risks involved in securitised instruments by focusing on clarity and transparency and hence allowing liquidity risk of loan originators to be comprehensively understood. Moreover, the efficacy of the existing regulatory framework requires the tripartite system of supervision (Treasury, Bank of England, and FSA) to assume a more alert role in order to avoid asset bubbles in the first place rather than intervening ex post.
The paper will give rise to a series of new research streams – all of which are much needed, given the fragile state of the financial systems.
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