Even in sober-suited City of London, there are queues outside Northern Rock. It's not only panicked pensioners who are withdrawing their cash, writes Laura Slattery.

In the heart of Europe's financial services sector, the Square Mile savers are joining in the exodus, happy to sacrifice a hot interest rate and join in the belief that the bank hasn't been nicknamed "Northern Wreck" for nothing.

On Monday, it is fair to say that things are looking a little wobbly for British banks, for consumers and for the political feelgood factor known as the "Brown bounce".

The share prices of two other British lenders, Alliance & Leicester and Bradford & Bingley, plummet amid fears of contagion from Northern Rock, while the chancellor of the exchequer, Alistair Darling, is forced to say the government will guarantee that all Northern Rock savers will get every penny of their money back. Amazingly, the same guarantee will apply to other banks that get into trouble.

"Bloody hurrah!" the bank's under pressure chief executive, Adam Applegarth, declares. Northern Rock will prevail, he says, like a deluded sci-fi villain facing imminent annihilation.

But confusingly for the British public who woke up to Black Monday headlines the next day, the mood in the City is sanguine.

The liquidity crisis in the money markets, now in its sixth week, is expected to lead to job losses - euphemistically termed "short-term retrenchment" - and more modest bonuses come Christmas time. But that's smaller bonuses than last year's record high cheques, while the clusters of cranes in the City and the Olympics hinterland beyond gleaming Canary Wharf point to only one conclusion: more crowded Tube train journeys.

Among the 340,000 financial services professionals already in London, thousands are dreaming up ways to make money out of the current carnage, even as the gossip flying from BlackBerry to BlackBerry is that more high-profile casualties are still to emerge.

There is also a hint of Schadenfreude about what has happened to "the Rock". The bank is characterised as an upstart that got too greedy, with overambitious management foolishly growing its loan book too fast by daring to undercut the big lenders.

"Inappropriate" is how John Stuttard, the 679th Lord Mayor of the City of London - a role that has existed since 1189 - diplomatically describes the strategy. The City, meaning the local government authority for the Square Mile, "won't tolerate anything that leads to systemic risk".

Everyone, including the mayor, is careful to link Northern Rock's problems back to the US subprime crisis or the bank's zest for profit. In no way is it a regulatory failure.

"Things go up and things go down and that is the essence of capital markets. If you want to make money, you have to take a risk. And in this situation, they got it wrong," says Stuttard.

"I think some of the riskier elements of practices in the industry will not return. But there will be a return to growth, after a slight dip, a slight downturn."

The cost of the credit crunch to the global banking industry is estimated to equal one year's banking profits - "not terminal", says Stuttard.

It is a little unnerving to hear grimly modern regulator-speak such as "checks and balances" and "principles-based regulation" from a man who wears a diamond-encrusted medal from the Elizabethan era in what is only the pared-down daily version of his official costume.

At the more sombre Financial Services Authority (FSA), these classic phrases are also in strong supply. The regulator is keen to dispel the "myth" that it is a light touch. To be principles-based - a phrase regularly used by our own regulator - is just an aspiration. It actually has a 5,000-page rulebook to brandish in the face of the City's army of compliance officers.

Still, no one wants the UK to overreact by introducing its equivalent of the US's onerous Sarbanes-Oxley legislation.

Paul Wright, the FSA's head of international strategy policy co-ordination, won't be drawn on Northern Rock. But he is willing to say that last week's dramatic liquidity injection by the Bank of England was evidence that the tripartite responsibility shared by the FSA, the Bank of England and the Treasury had worked "extremely well" in the crisis.

Nevertheless, the British press is starting to point fingers, asking why the FSA, with all of its analytical risk identification tools, failed to anticipate the perfectly understandable reaction of Rock customers who didn't want to see their life savings go down in a blaze of reassurances.

There are reports that the FSA and the Bank of England have actually been at loggerheads over the past few weeks, with the FSA angered by the UK central bank's refusal to intervene, despite clear evidence that troubles were looming at the lender.

Allowing the situation to continue unfettered has led to a terrible mess. The chancellor's guarantee to underwrite all bank savings has long-term consequences for the entire financial services industry, the least of which might prove to be its overnight re-igniting of the grievances of Equitable Life victims, who have questioned why bank savers have been given cushy guarantees while pension savers simply had to lump it.

A perhaps less easily resolved problem is that Darling's move has created what Bank of England governor Mervyn King has been fearing since the credit crunch first hit on August 9th - a "moral hazard".

While the European Central Bank happily pumped funds into the money markets to stop them from seizing up completely - thus acting as a safety net to Irish banks - King maintained that any bail outs would only encourage more reckless lending and higher levels of speculation, sowing the seeds of a future financial crisis.

This also gives the lie to the argument that protecting the solvency of financial institutions is the same thing as protecting the consumers who deal with them.

The Bank of England's emergency loan to Northern Rock was at punitive rates, allowing it to claim that it had not backtracked on its position. But with its £10 billion cash injection to the market on Wednesday, only one thought springs to mind: U-turn.

Heads seem set to roll, but there are winners in the debacle.

It is suggested that Lloyds TSB, who want to buy Northern Rock but only at a bargain basement price, told TV stations where to find the most disgruntled queues.

At the London Stock Exchange, they are hoping that the freeze on private equity deals might prompt more companies to raise finance via the Alternative Investment Market (AIM) index. And while some hedge funds have neared collapse during the liquidity crisis, others have collected very nicely, thank you.

The City is now chock-full of carbon traders, Islamic finance experts and physicists using equations to develop ever more speculative financial derivatives.

But in the past seven days it has taken nothing more than a good old-fashioned run on a bank to embarrass its regulators, politicians and chief executives.