Northern Rock problems stem from the credit crunch

As Northern Rock yesterday appealed to its customers not to panic and moved to reassure savers that their money was safe, the inevitable questions were raised as to what would happen next.

As well as the specific concerns of Northern Rock customers, people who bank elsewhere will be wondering if their institutions will be next.

The problems at Northern Rock stem from the so-called credit crunch, which has been caused by the sub-prime loan crisis in the US.

Something like one in five home loans in America is made to someone with a poor credit history (sub-prime), and lenders in the US have been hit by a rise in the number of repayment defaults coupled with falling house prices.

The reason the crisis has spread across the Atlantic is that banks sell each other “parcels” of debt on the international money markets in order to spread the risks associated with making loans.

So even though British and European banks have far tighter lending criteria than their peers in the US do, the ripple effect has been felt around the world.

No one quite knows how much anyone else has been affected by this global crisis, meaning that banks have become wary of lending to each other at the moment.

Inter-bank lending oils the wheels of the financial markets so when that lending slows down or dries up entirely, the whole thing comes to a stop.

So why has Northern Rock - the country's fifth largest mortgage lender - been so badly affected?

The main reason is that it is so strongly focused on the mortgage market. Most mainstream mortgage lenders offer a variety of other products, such as savings accounts, current accounts and insurance products.

But while Northern Rock is not exclusively a mortgage lender, the vast majority of its business concerns the advancing of loans to homeowners.

It is heavily reliant on wholesale money markets to raise cash for lending and it also raises money through the sale of bonds based on its mortgage debts - so-called asset-backed securities.

Its costs have soared as banks have stopped lending to each other and investors have become more cautious about buying asset-backed securities, all of which means that it has been hit harder than most.

Other institutions tend to have more balanced product portfolios, which is why most analysts believe it is unlikely that other banks and building societies will feel the effects as strongly as Northern Rock has done.

Ultimately, though, analysts agree that the Bank of England wouldn't have stepped in to help Northern Rock if it wasn't solvent or if there were serious fears that it would go under, and that is why the common wisdom seems to be for its savers to sit tight.

There are, however, a couple of points that many of us would do well to remember.

Rachel Thrussell, head of savings at Moneyfacts.co.uk, said while Northern Rock savers had statutory protection, it was worth spreading the risk.

“Savers should rest assured that Northern Rock is fully regulated by the Financial Services Authority, with funds also covered by the Financial Services Compensation Scheme,” said Ms Thrussell.

“This gives savers the peace of mind that the depositor protection scheme will provide £31,700 of cover should a company cease trading. This limit is per individual saver and is calculated as 100pc of the first £2,000 plus 90pc of the next £33,000.

“But savers should be aware in the case of other companies which are part of a group that this cover is based at group level rather than for the individual companies. So for savers with investments spread across the group, they will still only receive a maximum of £31,700.”

That means that if you have £60,000 in savings, for example, spread across accounts at HSBC and First Direct, which are part of the same group, you would only be eligible for £31,700 of cover in the extremely unlikely scenario that things went wrong.

You would do better to move half your money to an institution that had no links with HSBC.

Another thing to bear in mind is that now could be the time to get more bang for your buck.

Because of the difficulties in borrowing from each other at the moment, many banks and building societies are on the lookout to borrow more from us.

As a result, savings rates are on the up, so make sure you shop around for the best deals.

This week Stroud & Swindon Building Society relaunched its fixed-rate bond, increasing the rate to 7.05pc, up from 6.25pc, and Standard Life launched a bond with a rate of 7pc fixed for six months.

“Lenders are looking for alternative ways to fund their mortgage lending, and it seems as if increasing deposits has been the first port of call for many,” said Ms Thrussell.