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 banks' reluctance to lend as they hoard cash to cope with the fallout from bad U.S. loans.
The British government said on Friday it had authorised the Bank of England (BoE) to provide an unspecified amount of liquidity to Northern Rock, 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 its branches as customers scrambled to withdraw cash.
"You read the headlines in the paper, Northern Rock cash SOS. If you had money in there, what would you do?" said John Duncan, 51, a chartered surveyor who withdrew all his savings from a branch in London.
Banking System Sound
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 little exposure to poorer-quality, or "subprime," U.S. mortgages, Northern Rock has proved vulnerable to the liquidity squeeze triggered by the crisis in that market 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 said 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 6,500 staff. Its shares, already down almost 50% this year, plunged over 25%.
"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 stabilisation of the credit markets," said Landsbanki analyst Ian Poulter.
A Different Bank
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.
At 1320 GMT, Northern Rock shares were down 27.2% at 465 pence, valuing the bank at 2 billion pounds ($4 billion). Shares in rival mortgage lenders Alliance & Leicester and Bradford & Bingley fell over 8% each, while buy-to-let lender Paragon fell about 25%. However, all three said they had no need for extra funding.