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Lessons from the Rock for Europe’s banks

(Reuters) – In November 2010, rumors swirled through financial markets that Spanish bank BBVA (BBVA.MC) was suffering a run on its deposits. The share price fell before excitable traders realized they had made a mistake.

In fact the bank was holding a “fun run” in Madrid and customers had lined up outside its branches to get their T-shirts. In a jittery market, talk spread quickly and few things worry bank investors and customers more than talk of a run.

Nervous times have returned to the euro zone, and customers are worrying again about whether their savings are safe.

Banks, regulators and policymakers in Greece, Spain and across Europe are back on high alert to avoid a repeat of the most catastrophic risk for a bank — a loss of confidence among savers, or a run on the bank.

A run may start irrationally, but once it takes hold the panic can be entirely rational. No-one wants to be last in line if everyone else is pulling out their cash.

A run on Britain’s Northern Rock in September 2007 was one of the most sudden and shocking events of the financial crisis.

It was the first run on a British bank for more than 100 years and critics said it made the country look like a banana republic. Yet it is providing lessons on how to limit the damage in future.

“The key thing to learn is that runs can happen out of nowhere and once they start they are incredibly difficult to stop. And to stop them you have to do far more than you expect, and to do it far more quickly than you expect,” said Alistair Darling, Britain’s finance minister at the time.

“With what’s going on at the moment, it’s clear that many Greeks have taken their money out. If you’re not careful, a trickle can become a flow and it can then become an absolute torrent,” Darling told Reuters in an interview.

The dynamics have shifted, but there is now a greater risk that panic will spread to more than one bank.

“Northern Rock was a question about the soundness of the bank. Now the question is about the soundness of the government,” said Nicolas Veron at Brussels think-tank Bruegel.

“Then there is a related question – for countries that are at risk of leaving the EU, it could make sense to withdraw the deposits. It becomes a currency risk,” he said.

If Greeks fear their country could leave the euro, they may not want to keep their money in a local bank and risk seeing it devalued.

As a result, deposit insurance schemes can offer only limited support.

A guarantee helps, but not if there are doubts that the government can pay, and it doesn’t protect against currency redenomination, as in Argentina in 2001, when the value of deposits fell 20 percent.

Reassuring customers they will not lose money and strengthening the deposit guarantee scheme is nonetheless the biggest lesson learned from Northern Rock.

“It came as a bolt from the blue and people weren’t sure of their protection, and then there was some spectacular and sensational media coverage. It was difficult to control,” said a person involved with events at that time.

RUN ON THE ROCK

Northern Rock was caught on the back foot when news of its problems were reported by the BBC late one Thursday night.

The bank, which had grown rapidly to become Britain’s fifth biggest mortgage lender, had needed emergency funding from the Bank of England a few days before, having been frozen out of wholesale funding markets due to a reckless business model.

The BBC report caused panic among savers, which got worse when policymakers were slow to reassure them.

Thousands queued outside Northern Rock’s branches from early that Friday, over the weekend, and on the Monday. When Darling stood up to tell people their savings would be 100 percent guaranteed, the queues quickly disappeared.

Reassurance came too slowly and ministers were criticized for not doing enough to calm savers.

“Our lesson from Northern Rock is we let it run for three or four days, which was far, far too long,” Darling said.

“The problem was the government did not appear to be in control of events, and it wasn’t. It wasn’t until the Monday evening when I announced the formal guarantees that we were able to stop money leaving,” he said.

Although that slowed the visible run, deposits continued to be pulled from Northern Rock by online, postal and telephone customers in a so-called silent run.

About half of Northern Rock’s 24 billion pounds ($38 billion) of retail deposits were estimated to have been withdrawn.

Other banks also suffered silent runs during the crisis, including Belgium’s Fortis and U.S. lender Wachovia, and in the modern era that is seen as the biggest risk for banks.

It may lack the drama of a High Street panic, but big amounts can move quickly and easily at the click of a mouse.

Britain and other countries have made the rules on compensation less complex and more generous, and banks now regularly communicate that. Four years ago, only the first 2,000 pounds ($3,000) was fully guaranteed, and then 90 percent of the next 33,000 pounds ($52,000). Now it is 100 percent of 85,000 pounds ($133,000), and other European countries guarantee a similar amount.

Consumers are more financially aware. During Northern Rock’s crisis, a branch manager was barricaded in her office after refusing to allow one couple to withdraw 1 million pounds. Deposits are now typically distributed across more banks.

As well as being attacked for a poor communications strategy, British authorities were criticized for a lack of contingency planning, weak coordination between the Treasury, the central bank and the regulator, and lax supervision.

Risks at Northern Rock had been identified in “war games” held in 2005, but steps to address weaknesses were not taken.

But Darling said the Northern Rock crisis did mean the government acted sooner and more decisively a year later when Royal Bank of Scotland (RBS.L) was on the brink of collapse.

“We were determined that we would not let it happen again, and this time we were dealing with big global players … we had no hesitation in taking the action we needed to do,” he said.

SLOW RUN

Other banks have suffered runs before and since Northern Rock, and more will in future.

“If people think that their money might be at risk, it’s entirely rational for them to take it out,” Darling said.

In 1933, President Franklin Roosevelt took drastic action to halt a series of runs on U.S. banks, successfully calming savers with an effective 100 percent deposit insurance.

Greeks were last week rattled after the country’s president said savers had withdrawn 700 million euros ($875 million) in one day. That prompted a similar amount to be withdrawn the next day.

The exodus slowed, and there has been no sign of panic or queues at branches in Athens. But there had already been a slow run on Greek deposits — about 72 billion euros ($90 billion), or 30 percent, has been taken out since the start of 2010.

A bigger worry is that Madrid’s banking crisis or a Greek euro zone exit could prompt an exodus from Spanish banks.

Shares in Bankia (BKIA.MC) plunged last week after a report that 1 billion euros ($1.25 billion) had been pulled out by customers, forcing the government to deny the claim.

There has been no sign of panic in Spain, and the latest deposits data from its central bank showed a slight increase in March, although about 55 billion euros ($69 billion) has been withdrawn in the year to March, or 4.6 percent.

But Santander’s (SAN.MC) British arm did see 200 million pounds ($300 million) withdrawn last Friday after it was included in a Moody’s credit rating downgrade of Spanish banks.

Several local governments withdrew funds from Santander UK due to worries about its parent, Spain, or the euro zone, even though it is an autonomous subsidiary and is self-sufficient in capital and funding, showing the risk of a run is not just about retail customers.

Britain’s local authorities are risk-averse after many lost millions of pounds held in Icelandic banks.

Plymouth City Council told Reuters it removed funds from Santander UK on Friday, while Kent, Oxford and Waltham Forest said they had taken out deposits and were reviewing the situation. John Simmonds of Kent County Council said he was reassured that capital could not be drained by its Spanish parent, but he was now “waiting for the fog to clear a little”.

At least five more councils, including Westminster and Middlesbrough, told Reuters they had stopped depositing cash with Santander UK in the last two years, due to Spain and the euro zone concerns.

Unlike four years ago, there was a swift reaction to quell any panic, and the Financial Services Authority confirmed no money could be sent to bail out the parent. Santander UK said activity returned to normal the day after Friday’s withdrawals.

With the euro zone crisis likely to drag on, there have been calls for a pan-European deposit scheme to reassure savers in countries like Greece. But that would fail to protect against currency risk and would probably face opposition in Germany, which does not want to pay for more problems elsewhere.

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Osborne’s march of the makers limps towards a crucial budget

Manufacturers are being wooed as the economy’s salvation – but the sector still feels that politicians don’t understand what it really needs.

Five years ago, when the financial services boom was in full swing, Britain’s manufacturers felt like a Cinderella industry, neglected and ignored, as the Labour government knighted bankers and sang the praises of the City.

It was a measure of how much has changed that when the EEF, the manufacturing trade body, held its national conference in Westminster earlier this month, Vince Cable and Ed Miliband both delivered major speeches – followed by a guest appearance by the chancellor at a glitzy dinner that night.

Ever since George Osborne declared that he wanted to start a “march of the makers” in last year’s budget, politicians across the ideological spectrum have been assiduously wooing metal-bashers, carmakers and even obscure research scientists whose inventions might be money-spinners. Ed Miliband has called for a renewed sense of national pride in products that are “made in Britain”.

Manufacturing budget boost

Despite upbeat headlines, such as last week’s announcement that 1,000 new jobs would be created at the Jaguar Land Rover Halewood plant in Merseyside, the manufacturing sector still feels it needs more government support.

Yet there remains a sense of frustration in the business community that despite the cheerleading, politicians still don’t understand the challenges many firms are facing. British Chambers of Commerce director general John Longworth has lambasted politicians for undermining businesses, burdening them with red tape while expecting them to drive the recovery. He says his organisation is doing its best to point exporters towards what government support is available, but that, overall, Britain is “miles off” being business friendly.

“Exporters need to have the right sort of support to access the right markets … They need to have adequate confidence or access to capital in the home market and they need to be able to employ the right people,” he says.

Vince Cable’s department published a “plan for growth” alongside last year’s budget, which included a smorgasbord of measures on deregulation and government support.

But Steve Radley, the EEF’s head of policy, says: “Our concern, looking at it a year on, is: is the plan for growth sufficiently visible, and is it having the impact across Whitehall that it needs to have?” Cable himself clearly shares these concerns, judging by a highly critical letter to the prime minister about industrial strategy that was leaked to the press. Chuka Umunna, the shadow business secretary, says the letter highlighted an ideological gap within the coalition, as well as a problem of practical implementation: “I think there’s a real division within government about how to shape future growth. We’ve got to move away from the situation where business’s voice in government is reliant on the charisma and the clout of the secretary of state.”

The issue cuts across party lines: some in the Tory party – including backbench MP George Freeman (see right) would like to see the government shrug off the old, instinctive suspicion of state intervention via industrial policy.

But Umunna says the chancellor himself, despite his recent ringing words in support of the manufacturing sector, still doesn’t get it. “Osborne is wedded to the old orthodoxies where you have to leave it to the market. People forget that that bastion of free-market thinking, the US, has been incredibly interventionist. Osborne is outside the international mainstream thinking on this.”

So far, there is scant evidence that the government’s desire to boost industry is bearing fruit. Exports have certainly risen over the past year, as Osborne and other ministers had hoped; but a sharp improvement in the overall trade deficit has remained elusive (see chart).

And there is little likelihood that manufacturing will offer a solution to the deterioration in the labour market: today’s manufacturers tend to be more hi-tech and less labour-intensive than in the past. So despite upbeat headlines, such as Jaguar Land Rover announcing last week that it would take on 1,000 new workers, employment in the sector has continued to decline.

The international environment hasn’t helped. In the autumn, as the eurozone debt crisis raged, confidence in many sectors plunged as firms feared that demand from key continental markets would be badly affected.

Since the latest Greece bailout bought some time for Europe’s politicians, the mood has improved, but Radley says he remains concerned that investment will not be as strong as the government hopes. The Office for Budget Responsibility’s forecasts rely on business investment growth of almost 8% in 2012 and 9% in 2013 to drive economic growth.

Some analysts warn that this is the real problem any struggling small business will have to face over the next couple of years: even if they broadly agree with the chancellor’s approach to tackling the deficit, they will be operating in a climate where the government is sucking demand out of the economy.

“If you start from the position that what they think they should be doing is cutting in a weak economy, this is immediately setting up a high barrier to any recovery at all,” says James Meadway of the New Economics Foundation.

Many firms have healthy balance sheets after taking a cautious approach to expansion since the crisis. But it would hardly be surprising if in the current climate, with demand at home being hammered by cuts, they chose to cling to that financial comfort blanket instead of making risky investment decisions.

“There are huge question marks about whether the positive sentiment that we have seen coming through in business surveys will translate into investment,” Radley says.

Against this background, he says, many of the policies that have made the headlines in the discussions in the run-up to next week’s budget – on the 50p tax rate or a so-called “mansion tax” on £2m homes, for example – have had little to do with how to help business through tough times. Instead, he would like to see cuts in national insurance for firms taking on younger workers, additional support for apprenticeships and training, and higher capital allowances for firms buying equipment.

Osborne is expected to make a separate announcement in the runup to the budget this week about how his new national loan guarantee scheme, which will use government guarantees to underpin bank loans to small businesses, will work. Business groups say they will monitor its operation closely to see whether it is delivering genuine benefits to their members.

And when the chancellor stands up on Wednesday, businesses will be listening carefully for signs that Osborne meant what he said when he called for a march of the makers. Radley says: “It’s very hard to get a message across to business, which is why you have to work incredibly hard at it.”

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