Information and Intertemporal Decision Processes in Banking: The Run on Northern Rock

The run on Northern Rock was due to its business and funding model and to external events in global markets that prompted it to resort to the Bank of England for liquidity support. The vast majority of its funding was sourced from wholesale market depositors and these had more information, and earlier, on issues with Northern Rock's funding strategy than retail market depositors. In 2007, following an announcement of liquidity support to Northern Rock, retail market depositors reacted and there was a run on it. Deposit insurance was only partial and it was only when there was an assurance by the government that it would be extended to the full amount of deposits did the run discontinue. There was not a run on the banking system. A theoretical model of a bank run, based on those of Diamond and Dybvig, Jacklin and Bhattacharya, Alonso and Peck and Shell is proposed. This differs from previous models in that it is capable of generating a run on a bank, or a subset of banks, based on bank reputation, among other factors, when there is the same external shock for all banks in an economy. The model incorporates many of the characteristics of the Northern Rock run and is developed to reiterate, within the confines of such an analysis, these events.