The fine distinction between lender of last resort and a bail-out
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Your support makes all the difference.At first sight, the Bank of England's decision to provide emergency funding to Northern Rock directly contradicted its Governor's warning on Wednesday that he would not authorise bail-outs of banks caught up in the sub-prime crisis. Yesterday, the Bank was at pains to explain there had been no change of policy.
On Wednesday, the Bank said it would not inject emergency liquidity into the banking system, as other central banks have done in recent weeks, because doing so would encourage banks to go on taking excessive risk. It said the banks would have to accept the pain of taking sub-prime assets back on to their balance sheets.
Yesterday, the Bank said the Northern Rock situation was quite different. It was acting as lender of last resort to the mortgage bank because Northern Rock was facing liquidity – rather than solvency – problems, and, most importantly, because the failure of the bank would lead to serious economic damage. It also pointed out that Northern Rock would pay a penalty rate of interest for the funding.
The distinction is a fine one. However, a spokesman for the Bank insisted: "This is in no way a U-turn – we are not talking about a bail-out here."
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