Will cutting rates be beneficial for the public?
As the credit crisis deepens and more people are feeling the real impact as credit becomes more difficult to obtain, the focus on interest rates has never been greater. 12 months ago, only those connected to the financial services industry were aware of LIBOR and its importance in the marketplace. Today LIBOR is discussed in living rooms and pubs throughout the country with many of these discussions fueled by news reports on television.
The nation is now aware that LIBOR, the London Inter Bank Offered Rate reflects the actual rate at which banks borrow money from each other and is accepted as an accurate barometer of how global markets are reacting to market conditions.
The British Banking Association (BBA) works out the BBA LIBOR rate on any given day by taking the inter bank borrowing rates from 16 contributor panel banks and analyses the middle eight rates (dismissing the first 4 and the last 4) to arrive at an average rate.
Over the last twelve months the difference between the LIBOR rate and the Bank of England base rate has been substantial and it has also been acknowledged that the period of this variation is also longer than ever before. There has recently been a drop in the rate with a 1.065 percentage reduction on Friday 7th November giving a rate of 4.496% (its lowest point since April 2004), reflecting a slashing of the interest rate by 1.5% to 3% by the Bank of England. The pressure has been put on the financial institutions to pass this on to the general public, not only by the government, but also by the media. With this in mind, many of the leading banks are following the Bank of England's lead.
In clamoring for reductions to be passed on there are a number of factors that appear to have not been taken in to consideration;
Current customers will of course welcome a reduction in interest rates. For the bank, however, this can have a damaging effect on arrears performance. As borrowers are set to pay less monthly, this automatically puts up arrears percentages. For example, if a borrower normally pays 350 a month, but is 300 behind, they are effectively not an issue as yet. However, if those monthly payments are brought down to 290, that 300 in arrears is considered to be over a month's worth of payment, which then puts them on the problem list. This will have a knock-on throughout, as people who are 1month behind move to 2, 2 to 3 and so on. Therefore, the amount of people being litigated against will also increase.
Those bank's wishing to lend to other bank's at the LIBOR rate will take in to account the performance of the borrowing bank's mortgage book. This will have deteriorated considerably as a result of the rate cut and will deteriorate further with future cuts. This will obviously have a detrimental effect on a bank's willingness to lend, and could have a negative impact on LIBOR rates as the perception of risk increases, this will be priced accordingly.
This isn't the only way banks get funds though. Loans and mortgages are also funded by retail deposits and the moneys accumulated in the existing loan book. Those banks that have carried on functioning recently have done so based on retail funding. At the moment, the drive we saw in the past for mortgage business is now being focused aggressively on investment business.
The reduction in rates will result in banks receiving less income from existing borrowers, yet there is still the drive to compete for investment business. This will reduce profit margins and slow down the rate at which banks will recover. As banks compete for investment business, rates available are much lower than the LIBOR rate. This means that the banks strategies for obtaining liquid funds will remain firmly focused on retail business. LIBOR therefore has to fall to a level that is attractive to banks compared to the cost of attracting retail funds.
To summarise, there is little doubt that the government's actions have boosted confidence levels and created a positive impact on the money market. However there is still a long way to go, and many more challenges to overcome, and the cash injection and reduction in interest rates, although remedial, will still have a few nasty side effects. The irony is, as this article is written, LIBOR has gone back up to 5.65%, so who knows what to expect!
The nation is now aware that LIBOR, the London Inter Bank Offered Rate reflects the actual rate at which banks borrow money from each other and is accepted as an accurate barometer of how global markets are reacting to market conditions.
The British Banking Association (BBA) works out the BBA LIBOR rate on any given day by taking the inter bank borrowing rates from 16 contributor panel banks and analyses the middle eight rates (dismissing the first 4 and the last 4) to arrive at an average rate.
Over the last twelve months the difference between the LIBOR rate and the Bank of England base rate has been substantial and it has also been acknowledged that the period of this variation is also longer than ever before. There has recently been a drop in the rate with a 1.065 percentage reduction on Friday 7th November giving a rate of 4.496% (its lowest point since April 2004), reflecting a slashing of the interest rate by 1.5% to 3% by the Bank of England. The pressure has been put on the financial institutions to pass this on to the general public, not only by the government, but also by the media. With this in mind, many of the leading banks are following the Bank of England's lead.
In clamoring for reductions to be passed on there are a number of factors that appear to have not been taken in to consideration;
Current customers will of course welcome a reduction in interest rates. For the bank, however, this can have a damaging effect on arrears performance. As borrowers are set to pay less monthly, this automatically puts up arrears percentages. For example, if a borrower normally pays 350 a month, but is 300 behind, they are effectively not an issue as yet. However, if those monthly payments are brought down to 290, that 300 in arrears is considered to be over a month's worth of payment, which then puts them on the problem list. This will have a knock-on throughout, as people who are 1month behind move to 2, 2 to 3 and so on. Therefore, the amount of people being litigated against will also increase.
Those bank's wishing to lend to other bank's at the LIBOR rate will take in to account the performance of the borrowing bank's mortgage book. This will have deteriorated considerably as a result of the rate cut and will deteriorate further with future cuts. This will obviously have a detrimental effect on a bank's willingness to lend, and could have a negative impact on LIBOR rates as the perception of risk increases, this will be priced accordingly.
This isn't the only way banks get funds though. Loans and mortgages are also funded by retail deposits and the moneys accumulated in the existing loan book. Those banks that have carried on functioning recently have done so based on retail funding. At the moment, the drive we saw in the past for mortgage business is now being focused aggressively on investment business.
The reduction in rates will result in banks receiving less income from existing borrowers, yet there is still the drive to compete for investment business. This will reduce profit margins and slow down the rate at which banks will recover. As banks compete for investment business, rates available are much lower than the LIBOR rate. This means that the banks strategies for obtaining liquid funds will remain firmly focused on retail business. LIBOR therefore has to fall to a level that is attractive to banks compared to the cost of attracting retail funds.
To summarise, there is little doubt that the government's actions have boosted confidence levels and created a positive impact on the money market. However there is still a long way to go, and many more challenges to overcome, and the cash injection and reduction in interest rates, although remedial, will still have a few nasty side effects. The irony is, as this article is written, LIBOR has gone back up to 5.65%, so who knows what to expect!
About the Author:
Mortgage Route gives assistance help and advice on mortgages from fully trained mortgage brokers along with no obligation mortgage calculators and sourcing tools.
posted by Debt Consolidation Loan at
1:02 AM
0 Comments:
Post a Comment
Subscribe to Post Comments [Atom]
<< Home