Banks could be stretched by Northern Rock fallout

The fallout of the problems faced by Northern Rock could cause many lenders to tighten their operations in the next five years, it has been suggested.

When the government stepped in to reassure consumers that they would not lose their deposits should Northern Rock go out of business, it became clear that the current safety net for customers with money in struggling banks was inadequate. Only pronouncements from chancellor Alistair Darling that the government would ensure all money lost would be returned to consumers in the event that Northern Rock went bust were enough to stop long queues forming outside the bank's branches across the country.

The current system to guarantee only a limited amount of money back in the event that a lender goes out of business is now under review and many experts in the financial industry believe that the UK's Financial Services Authority (FSA) is considering implementing a scheme similar to one already in existence in the US. Under that approach, banks and lenders all put some money into one central insurance scheme so that if one lender goes bust, funds from the central pot will be provided to ensure consumers are able to regain the majority of their money.

However, analysts have warned that replicating such a scheme in the UK could cost financial institutions a total of £3 billion per year until at least 2012. Investment bank UBS has warned that this translates to around eight per cent of retail banking profits, putting a significant burden on British banks.

Such an encumbrance would be all the more difficult for lenders to bear because of the present credit crunch affecting the global markets. Since the bottom fell out of the US sub-prime market, there has been a tightening of credit and lending habits across the world and therefore many banks would be looking to the UK government to help ease their difficulties, rather than adding to them with such a scheme.

Alastair Ryan, an analyst at UBS, said in a research note that the UK government would not be keen to donate to a central pot itself and would demand that lenders contribute to the insurance system. According to Reuters, Mr Ryan explained in the note: "We doubt the government is keen to have direct taxpayer support for the banks as a default outcome and we also note that UK retail banking is a highly profitable undertaking."