The European Commission has approved government plans to split Northern Rock in two in a move that will see the lender's market share halved from pre-crisis levels and see the taxpayer handing over an extra £8 billion.

Northern Rock's savings accounts and a 'small amount' of mortgages will be split from the the unsecured loans and the vast majority of mortgages still held with Northern Rock, with a view to creating a 'good bank' that can be sold at some later date.  

The rest of the business will be managed and eventually 'run down' by the UK Financial Investments Ltd - set up to manage the bank assets owned by the government.

The new group will manage the vast majority of Northern Rock's mortage loans and all of its unsecured loans, including those currently controlled by Granite - the special-purpose vehicle originally set up to sell off part of Northern Rock's mortgage book to bondholders. 

The overwhelming majority (90%) of the mortgages held by the new entity Northern Rock (Asset Management) are fully-performing and not in arrears, Northern Rock said in a statement today.

A spokesperson said it was incorrect to call the new company - which will not write new mortgages - a 'bad bank' even though that is the term used by the Commissioner.

Competition Commissioner Neelie Kroes said splitting the 'bad bank' assets off from the rest of the business ' would increase the 'good' bank's long-term viability as it will have only limited exposure to Northern Rock's risky past lending.'

'Therefore, it will be able to operate without state support in the long-term and will be eventually sold to a third party,' she said.

Northern Rock said the split can be completed by the end of the year, leaving the way open for a sale in the new year.

Such a move could raise around £11 billion and would be the first step towards making government claims the taxpayer can make a profit from the banking sector bailout a reality.

Excessive expansion

Kroes said the restructuring moves 'will correct the excessive expansion of Northern Rock pre-crisis and its market share will be less than half of the pre-crisis level.'

Northern Rock grew fast in the boom years as it bet on rising house prices and wrote a number of riskier mortgages including the now infamous 125% loan to value 'Together' mortgages.

But as the US market began to falter Northern Rock found it increasingly difficult to fund itself in the wholesale markets and sought aid from the government - eventually leading to a run on the bank.

Despite a number of potential bidders expressing interest in buying the business, the government eventually decided to nationalise the lender.

Initially Northern Rock attempted to pay the money back as quickly as possible, signing a deal with Lloyds to persuade customers to switch their mortgages and freeing up cash to pay back to the taxpayer.

By this time last year, Northern Rock had paid back nearly half of the £27 billion it had originally borrowed.

But as arrears rose and with UK borrowers frozen out of the market, the lender made an about turn and pledged to begin lending again.

Today, Kroes said the restructuring deal will enable the 'good' bank to continue to provide lending to the real economy.

Kroes said she was satisfied that the aid from the government is compatible with the EU rules on state aid. 

And while some have suggested it would have been better to let Northern Rock fail, Kroes said 'The failure of Northern Rock would have had major detrimental effects on the UK mortgage market and the overall financial stability of the UK economy.'

No impact on customers

'For Northern Rock customers it is business as usual and they need take no action.  The aim is to make this process as seamless as possible, and customers will be kept informed of progress,' the banking group said.

It said the company website would be regularly updated and all customers will be informed in writing once the restructure has completed - by the end of the year.

Northern Rock will continue to lend and to take desposits but has agreed to some strict caps on growing its business:

• To limit new lending volumes to £4 billion in 2009, £9 billion in 2010 and £8 billion in 2011. 
• To maintain retail deposit balances across the UK, Ireland and Guernsey at or below £20 billion until the end of 2011. 
• Northern Rock agrees it will not rank in the top three of Moneyfacts mortgage categories for 2, 3 or 5 year fixed or variable mortgages before the end of 2011 (excluding mortgages with an LTV ratio of greater than 80% and products for first time buyers).