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Did the market signal impending problems at Northern Rock? An analysis of four financial instruments

Author

Listed:
  • Maximilian J. B. Hall

    (Dept of Economics, Loughborough University)

  • Paul Hamalainen

    (University of Essex, Colchester, Essex, England, CO4 3SQ)

  • Adrian Pop

    (University of Nantes, 44322 Nantes Cedex 3, France)

  • Barry Howcroft

    (Loughborough University, Loughborough, Leicestershire, England, LE11 3TU)

Abstract

The academic literature has regularly argued that market discipline can support regulatory authority discipline to monitor banking sector stability. This includes, amongst other things, using forward-looking market prices to identify those credit institutions that are most at risk of failure. The paper’s key aim is to analyse whether market investors signalled potential problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities at the Bank of England in September 2007. A further aim of the paper is to examine the signalling qualities of four financial market instruments so as to explore both the relative and individual qualities of each. Therefore, the paper’s findings contribute to the market discipline literature on using market data to identify bank risk-taking and enhancing supervisory monitoring. In addition, the paper tests for evidence of an implicit “too-big-to-fail” policy in UK banking. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities. These findings lend some empirical support to proposals for the supervisory authorities to use market information more extensively to improve the identification of troubled banks.

Suggested Citation

  • Maximilian J. B. Hall & Paul Hamalainen & Adrian Pop & Barry Howcroft, 2008. "Did the market signal impending problems at Northern Rock? An analysis of four financial instruments," Discussion Paper Series 2008_11, Department of Economics, Loughborough University, revised Oct 2008.
    • Handle: RePEc:lbo:lbowps:2008_11
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    File URL: http://www.lboro.ac.uk/departments/ec/RePEc/lbo/lbowps/HamalainenEtAl.pdf
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    Cited by:

    1. John Barry Howcroft & Rehan ul-Haq & Chris Carr, 2010. "An examination of cross-border strategies in banking," The Service Industries Journal, Taylor & Francis Journals, vol. 31(13), pages 2091-2109, June.
    2. Apanard P. Prabha & Clas Wihlborg & Thomas D. Willett, 2012. "Market Discipline for Financial Institutions and Markets for Information," Chapters, in: James R. Barth & Chen Lin & Clas Wihlborg (ed.), Research Handbook on International Banking and Governance, chapter 13, Edward Elgar Publishing.

    More about this item

    Keywords

    Banking regulation; bank failures; market discipline; early warning signals.;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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