What the nationalisation of Northern Rock means for you

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Northern Rock is the first company to be nationalised since Rolls Royce was taken under state control in the 1970s.

The Chancellor, Alistair Darling, recently announced the Government's intention to nationalise the bank, after he ruled out two rescue bids from Virgin Money and Northern Rock's existing management team saying that they posed too great a risk, with too small a reward for taxpayers.

We look at why this has happened and ask what it means for consumers.

Why did Northern Rock find itself in such financial difficulty?

Banks and building societies use various methods to raise funds for mortgages. These include using the money held in deposit accounts, borrowing from the wholesale markets, where banks lend to each other, and selling existing mortgage debts on to other institutions to raise funds for new home loans - this is a process known as securitisation.

Northern Rock relied more heavily on securitisation and buying funds from the wholesale markets, than most of its UK counterparts but this strategy ran into trouble last summer.

Steep interest rate increases in the United States led to a huge increase in the number of homeowners unable to meet their mortgage payments. Worst affected were sub-prime borrowers - those on low incomes with poor credit histories.

However, the ramifications of the American mortgage problem spread worldwide and sparked the global credit crisis. This was because most of the debts had been re-packaged and sold on to other banks and financial institutions. As a result the wholesale market virtually dried up - institutions were nervous about lending to one another because they didn't know which firms had been directly affected by the US sub-prime crisis.

Demand for mortgage-backed securities also pretty much evaporated because of worries that other borrowers, and not just those in the US, would slip into arrears.

This hit Northern Rock badly and it was forced to borrow money from the Bank of England in order to meet its mortgage commitments. In turn many existing customers lost confidence, and in September we saw the first run on a British bank for more than a century as thousands of savers sought to withdraw their funds.

Since then the Government, and taxpayers, have effectively been propping the bank up - Northern Rock has borrowed around £30billion from the Bank of England and in order to stem the outflows from savers, the Government guaranteed that all of their savings would be protected in the event of the bank going bust. With every other bank or building society, only the first £35,000 of your savings is guaranteed.

It was hoped that another private company would buy Northern Rock, but with so much public money at stake if any rescue plan failed, the government decided that nationalising the bank was a better option.

What does nationalisation mean?

Nationalisation is when the Government takes a privately-owned business under state control. The Chancellor has said this is only a temporary measure, and that Northern Rock will be re-privatised when it has recovered from its problems. However, analysts warn that could be years rather than months.

How does this affect mortgage customers?

As far as the day-to-day running of the bank goes, it is business as usual so you if you have a mortgage with Northern Rock you will just continue making your monthly payments.

However, it is unclear how competitively priced its products will be for new borrowers and those coming to the end of their current deals. Because of its funding problems Northern Rock has effectively priced itself out of the market in recent months - its doors are officially still open to new customers but it has increased its mortgage rates so that they are no longer competitive.

It may seek to improve its competitiveness once it is fully nationalised in order to try and rebuild its position in the market. However, EU rules on state-aid may restrict the bank's ability to offer the best rates as the Government funds cannot be used to pull in business by offering knock-down rates.

Certainly for the time being at least, anyone coming to the end of a mortgage deal with Northern Rock should look to switch to a different lender.

What about savers?

Northern Rock is the safest bank to have any savings with at the moment because your money is fully guaranteed. Under the Financial Services Compensation Scheme (FSCS), only the first £35,000 held with a bank or building society is protected in the event of it going bust, but the Government is guaranteeing all funds held with Northern Rock to deter savers from moving it elsewhere and making the bank's problems worse.

It is unclear how long the 100% guarantee will apply to deposits with Northern Rock, but the bank has confirmed that will give three month's notice if there is any change.

And while its mortgages don't look attractive, Northern Rock is offering some of the best savings rates as it seeks to pull in money to reduce its reliance on the Bank of England and wholesale funding markets.

Its Tracker Online is paying 6.49%. This is an easy access account so you can access your money at any time and the rate is available on balances above £1. It does however, include a one-year bonus of 1.24 percentage point bonus so after 12 months the rate will drop to 5.25%.

There are a few easy access accounts with slightly higher rates - West Bromwich building society's Star account for example, is paying 6.55% on balance above £1, although if you put money in to this account only the first £35,000 is totally protected.

Northern Rock also has one of the leading fixed rate bonds. Its one-year bond has a rate of 6.45%, which looks competitive given that Bank rate is 5.25%. Again you can get a higher rate - West Bromwich has the leading deal at 6.86%. If you have a large sum to invest Northern Rock is probably a better option, not only because the full balance is guaranteed by the government, but the maximum investment is £2m, compared with £1m with West Bromwich.

However, with fixed rate bonds, only invest money that you can afford to lock away because you withdrawals are not usually permitted during the fixed rate period.

If you want to take advantage of one of Northern Rock's leading savings products, don't hang around. Because of the state-aid rules it may not be able to offer such attractive rates for much longer.

Kevin Mountford, head of savings at moneysupermarket.com said: &qout;It's certainly where I would be putting my money. With the Government guaranteeing 100% protection it's a no-brainer, but we don't know how long these rates will last so you need to act quickly."

What about shareholders?

Northern Rock's shareholders are the biggest losers from the Government's decision to nationalise the bank. Shares were suspended on Monday morning, having closed at 90p on Friday, but the Northern Rock's 180,000 private shareholders may get nothing. This will be a bitter pill to swallow given that the shares were trading above £12 this time last year.

Shareholders will battle for some compensation, but there is no guarantee that they will get any money back. An independent valuer will assess how much the shares are worth, but given that the bank may have gone into administration if it were not for the government's financial help, they could be deemed worthless. However, Northern Rock does own valuable assets, including its branch network, so shareholders will argue that the business retains some intrinsic value.

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