Ron Sandler, the chairman of Northern Rock, conceded yesterday that the creditworthiness of his borrower base would get progressively worse as good risks defected to rival lenders.

“There will be a degree of adverse selection,” he admitted, as borrowers with good credit histories were able to switch to more competitive products, leaving Northern Rock with the poorer risks.

Some borrowers are stranded with the bank because of their poor credit histories or because they are unable to come up with a 10 per cent deposit required now by almost all banks.

In a trading update, Mr Sandler revealed that the proportion of mortgage borrowers in arrears had risen by 67 per cent in the past four months.

Of its 700,000 mortgage borrowers, 0.95 per cent - or 6,650 households - were in arrears, up from 0.57 per cent at the end of December. Arrears are defined as borrowers more than three months behind in repayments.

Mr Sandler said that the deterioration was because of a decline in general market conditions. He did not think that borrowers were more prepared to default because they believed they would be treated more gently now that the bank was in government hands. Arrears were going to continue to worsen, Northern Rock said, because of its plan to adopt a more robust accounting treatment.

Mr Sandler added that the overall credit quality of the loan book was satisfactory. Northern Rock was succeeding in shrinking back its balance sheet, encouraging borrowers to move elsewhere in an attempt to maximise proceeds and so speed repayment of its loans to the Bank of England.

Arrears and bad debts on the Rock's £8 billion book of credit card loans and other unsecured debt was “nothing out of the ordinary,” Mr Sandler said.

Northern Rock owed the Bank of England £24.1 billion at the end of March and these loans were continuing to be paid back in line with expectations. The bank also revealed that it was beginning to win back depositors, with total balances up to £12.8 billion by the end of the March, compared with £10.5 billion at the end of December.

Northern Rock collapsed last autumn when it fell short of ready cash because of the credit crunch, leading to panicking queues outside branches. The Government guaranteed all deposits and, after a fruitless search for a private sector rescuer, the bank was nationalised in February.

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