The Bank of England has offered an emergency loan to Northern Rock after the mortgage lender became the biggest British casualty of the credit squeeze sparked by the crisis in the U.S. subprime mortgage market.
The British central bank's support -- the first time it has acted as lender of last resort in this way since becoming independent on interest rate policy in 1997 -- puts a prop under Northern Rock, which has been hit by a spike in the cost of borrowing from other banks as they become increasingly reluctant to lend.
The British government said on Friday it had authorized the Bank of England (BoE) to provide an unspecified amount of liquidity to Northern Rock, the UK's eighth-largest listed bank, which had the biggest share of the new mortgage market in the first half of this year.
The BoE, which has come under fire from some financial institutions for its hands-off response to market turmoil, said Northern Rock was solvent and only in need of short-term help.
But queues formed outside some branches of the Newcastle, England-based bank, as customers looked to withdraw deposits.
Finance Minister Alistair Darling told BBC Radio that Northern Rock was the only institution to have called for BoE aid and that Britain's economy and banking system was sound.
There is plenty of money in the system, the banks have got money ... they are simply not lending in the short-term way that institutions like Northern Rock need, he said.
While it has no exposure to subprime loans, Northern Rock has proved vulnerable to the liquidity squeeze triggered by the U.S. subprime lending crisis because it has a small deposit base and so has to draw most of its funding from money markets.
Interbank lending costs rose to their highest level for nine years this week as banks scaled back lending to each other.
Northern Rock declined to comment on the details of the financial support, though Chief Executive Adam Applegarth told reporters that clearly a substantial amount is required and that it would be charged a penalty interest rate.
The firm warned higher funding costs and a decision to rein in lending would hit profits this year and next, and that there could be job losses among its 6,000 staff. Its shares, already down almost 50 percent this year, plunged a further 25 percent.
The only potential short-term fillip for the share price would come from an acquisition by a bank with the capability to fund the business on an ongoing basis or a stabilization of the credit markets, said Landsbanki analyst Ian Poulter.
Other banks, like Barclays, have obtained overnight funding under the BoE's standing emergency lending facilities. But the package for Northern Rock was the first time the BoE has been called on for longer-term help during the current crisis.
The BoE made it clear earlier this week that it would not bail out insolvent companies and has come under fire from some institutions for making less money available than other central banks, such as the European Central Bank.
The Financial Times Deutschland said on Friday, without identifying its sources, that some large British lenders were borrowing cash from the ECB via subsidiaries because of the BoE's reluctance to lend.
At 0910T, Northern Rock shares were down 21.8 percent at 500 pence, valuing the bank at about 2.2 billion pounds ($4.5 billion). Shares in rival mortgage lenders Alliance & Leicester
and Bradford & Bingley fell over 7 percent each, while buy-to-let lender Paragon fell over 20 percent.
Bradford & Bingley said it was well funded for the next half year. Alliance & Leicester and Paragon declined to comment.
Northern Rock's Applegarth urged customers to remain calm.
But more than 20 people were queuing outside the bank's Moorgate branch in London, looking to withdraw money.
I'd rather take my money out, just to be safe, said Steve Dixon, a customer at that branch.
Applegarth said Northern Rock, which used the cheap borrowing costs of recent years to expand aggressively, would emerge a different bank.
Our mix of funding will change going forward. Will we have greater dependence on retail deposits? Yes. Will we be growing slower? Yes. It will be a different Northern Rock, we will evolve to adapt to the market conditions, he told reporters.
Northern Rock said it now expected an underlying 2007 pretax profit of 500 to 540 million pounds ($1.1 billion), compared with analysts' current consensus forecast of 647 million.
(additional reporting by Jonathan Cable, Marc Jones, Dan Lalor)