According to the Telegraph newspaper, the FSA is turning a blind eye and permitting the bank to carry on operating and writing new mortgages, despite it being in breach of its capital requirements.

Last year the regulator put aside its rules by allowing Northern Rock to include the less secure form of financial reserve, tier two capital, in order to meet its regulatory minimum.

Yesterday, the bank said that in spite of the waiver, the bank’s capital has now “reduced to a level below its minimum regulatory capital requirement.”

The bank added that “the FSA has confirmed that it does not currently intend to restrict the activities of the company while the plan is implemented to address its capital position.”

Northern Rock needs state aid clearance from the European Commission in order to address its capital position. The lender is looking to convert £3 billion of the taxpayer’s £14 billion loan into equity to recapitalise as part of restructuring.

The plan will also involve all of its bad loans being put into a “bad bank”, with the £10 billion of good loans, branches and deposits going into a separate good bank.

It is hoped that the restructuring plan will enable the “good bank” to be sold to the private sector quickly and easily. Companies that have been linked with buying Northern Rock so far include Tesco Personal Finance and Virgin Money.

Analysts have estimated that in order to breach the FSA’s lax capital rules, Northern Rock must have lost over £500 million since the beginning of this year.

Last year the bank made a £1.36 million loss after £1.15 billion of bad loans and provisions. A third of its £76 billion mortgage book was said to be in negative equity.