Britain threw a fresh lifeline to Northern Rock on Tuesday, offering to guarantee new retail deposits and extend funding arrangements in a bid to win the bank time to salvage something from its battered business.
The latest aid package came as the head of the country's financial services watchdog said Northern Rock may not have needed to draw on emergency funds from the Bank of England at all if its rescue had not been conducted in the full public glare.
Northern Rock, which saw a run on deposits last month after it was forced by the global credit crunch to seek emergency funds from the BoE, said the new package would cost it 40 million pounds ($82 million) to 50 million pounds this year -- around 10 percent of its targeted 2007 profit.
But the bank said the new help would buy it time to assess its full range of options, which include being taken over as a whole, being broken up or attempting to remain independent -- a review process it said should be completed by February.
Analysts said the new arrangements could help to reassure prospective buyers and allay fears of shareholders and bondholders of a fire-sale of assets.
But the arrangements were also controversial, as the decision to guarantee new retail deposits could potentially give Northern Rock an advantage over competitors, they said.
If my mother were to ask me where she should put her money at the moment, I would say Northern Rock, Numis Securities analyst James Hamilton said. What (prospective) buyers will want to know, is how long these arrangements will last and whether they will continue (after a deal).
Northern Rock said the arrangements would remain in place during the current instability in the financial markets and that it would pay an appropriate fee ... to ensure that it does not receive a commercial advantage.
The British government had previously agreed to guarantee retail deposits made with Northern Rock before September 19. It said on Tuesday it would extend this guarantee to all new deposits made since that date.
It also said it would offer additional funding from the BoE on more flexible terms, which will allow Northern Rock to also use commercial lending as and when it can.
News of the agreement lifted Northern Rock's shares, which had plunged as much as 90 percent this year. At 1020 GMT, the stock was up 21 percent at 209 pence.
The situation must have been pretty near death, but Northern Rock now gets almost five months to find a buyer, Royal Bank of Scotland analysts said. The timeline could encourage bigger banks to take a look if wholesale markets start to recover
Separately, the head of Britain's Financial Services Authority (FSA) said a covert operation to save Northern Rock would have been an attractive option, but was not possible under the country's regulations.
They (Northern Rock) needed the insurance of opening up a facility with the Bank of England. They would not have had to use that facility had there not been the retail run, FSA Chief Executive Hector Sants told parliament's Treasury Committee.
Britain's financial regulations, overseen by the government, BoE and the FSA, have come under fresh scrutiny after news of Northern Rock's problems sparked the first run on a British bank since the 19th Century.
BoE Governor Mervyn King has also expressed regret that the bank could not have been helped covertly.
Northern Rock said talks were continuing with potential suitors and that it was being advised by Citi and Merrill Lynch.
Sources familiar with the matter have said U.S. buyout firms Cerberus and JC Flowers are considering moves on the bank, and British and U.S. newspapers have since also named Blackstone, Lone Star and Apollo as possible suitors.
According to prices from Deutsche Bank, the cost of insuring Northern Rock's senior debt against default was little changed after the news at 210 basis points. That means it costs 210,000 euros per year to insure 10 million euros of Northern Rock debt against default in the credit derivatives market.
(Additional reporting by Mark Potter, Sumeet Desai and Richard Barley)