News of Northern Rock's call for help from the Bank of England on Thursday night understandably sent panic waves around Britain yesterday. For many, the first they heard of the emergency was when they saw pictures on television of lengthy queues forming outside branches of the bank – as hundreds of people rushed to cash in the money from their savings and current accounts.
The scenes were more reminiscent of the 1929 depression in America than 21st-century Britain; but the situations are very different. So it's important to put the Northern Rock's dilemma into context.
Northern Rock's problems have been caused by the crisis in the credit markets over the past few weeks, which has seen banks become increasingly wary about lending to each other.
The credit crunch began because a number of mortgage lenders in the US had been lending too much and too freely to consumers with poor credit ratings. As interest rates increased in the US; many of these borrowers were unable to keep up payments on their loans. Unfortunately, this was not just a problem for the banks that lent them the money.
Many lenders packaged up their books of so-called "sub-prime" mortgage debt and sold it to other institutions around the world in the form of high-yielding bonds. When the borrowers stopped paying their mortgages, the bonds were no longer worth as much as the institutions who had bought them thought. This caused a crisis of confidence in debt markets around the world – amplified by the fact that it was not clear exactly how exposed various companies were to the sub-prime crisis.
Although Northern Rock has a perfectly good quality loan book, it makes the majority of its profits from mortgage lending – and has also been willing to lend slightly higher amounts to some new borrowers than other banks. This left the markets particularly reluctant to lend it money over the past few weeks – and as a result, it was forced to go to the "lender of last resort", the Bank of England, to ask for a loan to tide it over.
But this is merely a problem caused by the short-term credit crisis. In fact, the Governor of the Bank of England himself has said that he would only lend to banks which were suffering because of the short-term credit crunch. As far as Northern Rock customers go, it's business as usual. If anything; we may see them raise savings rates over the coming weeks, to try and attract more money onto its books.
"Consumers need to understand that the problem for lenders generally at the moment is in raising funds, not in lending quality," says Michael Coogan, the director general of the Council of Mortgage Lenders. "The Bank of England would not have provided the loan to Northern Rock if it had concerns about the quality of the lender's own business.
"All lenders are facing funding pressure at the moment, and what they need is a return to more normal market conditions as quickly as possible. We welcome the Bank's intervention and confirmation that it is keeping a close eye on the situation."
Nevertheless, the Northern Rock situation certainly focuses minds. Although the chances of a bank going bust in the UK are incredibly slim, it's worth remembering that there's an excellent protection system in place to safeguard investors' money if the worst ever happened.
The Financial Services Compensation Scheme will pay out up to £31,700 to deposit account customers – protecting 100 per cent of your investment up to the first £2,000; and then 90 per cent of the next £33,000. When it comes to investments rather than deposit accounts; the fund will pay out up to £48,000s, including 100 per cent of the first £30,000.
Even when it comes to general insurance – such as your car or home policy – you would still be covered if your insurer went bust. (For more information, visit the fund's website at www.fscs.org.uk).
Of course, the only way to be certain of not losing a penny is by keeping no more than £2,000 in any one savings account – or if you are happy with the idea of receiving 90 per cent compensation, then no more than £31,700. However, if your money is with a big name organisation, you should not need to worry.
Rachel Thrussell, Head of Savings at Moneyfacts.co.uk, the money search engine, says: "For many years it has been taken for granted that the UK banking industry is almost invincible, but with recent uncertainty, savers may be wise to take account of where their savings portfolio is invested.
"It's very unlikely that Northern Rock will be allowed to go under; it is likely that the Bank of England will continue to provide support or the company will prove to be a ripe catch for a competitor takeover."
For those who still want to move some of their savings, the good news is that rates are at a nine-year high. The Government-backed National Savings and Investments, for example, will pay you 6.3 per cent in its cash Isa – more than half a percentage point above the Bank of England base rate.
For details of the current best offers on savings and current accounts, visit www.moneyfacts.co.uk