From the editor’s desk

Run on trust

The spectacle of queues forming outside banks with crowds desperate to withdraw their savings is one that is perhaps more redolent of Latin America than northern Europe. Yet the scenes witnessed at branches of Northern Rock might not simply concern one former building society turned bank but may prove to be the beginning of a wider crisis of confidence in the banking system itself. If so, then all of the guarantees offered by the Bank of England and the Treasury will be ultimately ineffective. Banking is fundamentally about trust. If that trust disappears then the consequences could be truly catastrophic.

The banks themselves should be asking whether it is their own deeds rather than the irrational fears of their customers that have created this situation. Northern Rock developed a business model based not on the deposits of those saving with them but on aggressively lending large amounts of money based on many multiples of income and financing this by borrowing heavily on the money markets. When concerns about the impact of ill-advised lending in the American mortgage sector led banks to decline to trade each other money, as is customary, then the business found itself in trouble. It had to turn to the Bank of England and its reputation as well as its share price crashed. After all, if banks will not offer Northern Rock money, why should ordinary people?

The broader lesson here is that the banks have to be more responsible in their dealings. It has been too easy to borrow huge amounts of money and be desperately vulnerable if either interest rates increase by more than anticipated or if property prices fall. This occurred in the 1970s and 1990s, and inflicted severe social as well as economic damage. Those hurt most in these incidents are the poorest in society, because whenever a credit crunch follows a credit carnival it is they who are denied future resources. That is already happening, unfortunately, in the United States. It must not be repeated here.

There is, nevertheless, the danger that it might. Financial institutions and Ministers have been too content to allow the level of personal debt to escalate. Credit is indeed a crucial component of a dynamic economy, but when it is provided on the assumption that unemployment will always remain low, interest- rate levels can be predicted confidently and the value of a house will increase every year, then it becomes reckless. Britain has by far the highest level of credit-card debt in Europe and it has reached an extent that a vast new industry has emerged in which debt is being marketed principally as a device to pay off other debts accumulated on the likes of Mastercard and Visa. This situation cannot be sustained indefinitely. The banks need to reassess their practices immediately.

If they do not, then the trust factor will loom even larger. One of the most disturbing elements in this episode is that not only did Northern Rock's depositors not trust the organisation into which they had placed their savings but they displayed little faith in the words of senior public servants at the Bank of England or in the Chancellor of the Exchequer. Trust has been diminished across the board in recent years and replaced by a corrosive cynicism. This is a development with dire implications well beyond banking.