Liquidity, Bank Runs and Bailouts: Spillover Effects during the Northern Rock Episode

Abstract

In September 2007, Northern Rock - the fifth largest mortgage lender in the UK - experienced an old-fashioned bank run, the first bank run in the UK since the collapse of City of Glasgow Bank in 1878. The run had been contained by the bailout announcement of the government that guaranteed all deposits in Northern Rock. This paper analyzes spillover effects during the Northern Rock episode and shows that both the bank run and the subsequent bailout announcement had significant effects on the rest of the UK banking system, measured by abnormal returns on the stock price of banks. The paper also shows that the effects were a rational response of investors to market news about the liability side of bank balance sheets. In particular, banks that rely on funding from wholesale markets were significantly affected, which is consistent with the drying up of liquidity in wholesale markets and the record high levels of the London Interbank Offered Rate (LIBOR) during the crisis.

Keywords: contagion, bank run, liquidity, event study, systemic risk, bailout

JEL Classification: G21, G14, G28, E58, D62