Interest Rate Cut - Good or Bad for customers
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.
As a nation, we are now all aware that LIBOR, or the London Inter Bank Offered Rate, is the rate at which banks borrow from one another, and is therefore a benchmark for how the lending markets worldwide should react.
The British Banking Association (BBA) takes the inter-bank borrowing rates from 16 contributor panel banks and looks at the middle eight of these rates (discarding the top and bottom four) and uses these to calculate an average, which then becomes that day's BBA LIBOR 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;
Now, as I have said, the drop in the interest rate would seem to be welcome news for all concerned. But it pays to look at this from the banks point of view. If they pass on the rate drop and it applies to someone who is in payment arrears then this could be detrimental for both the customer and the bank. For example say you have a customer who has monthly payments of 350 and is in arrears of 300 would not necessarily be perceived as a risk. Now say the rate is passed on and his monthly payment drops to 280. This means that the customer is more than one month in arrears. This creates a domino effect because with each passing month the debt is not being cleared and more is being owed. It soon gets to the stage where this will be seen as a bad debt and put in the hands of solicitors for collection. Not a good position to be in.
Banks who wish to lend to other banks at the LIBOR rate will be looking at the performance of the borrowing bank's mortgage book. This will inevitably have slipped with the decrease in rates, and will of course only slip further as more cuts happen in the future. As a result, banks will become more unwilling to lend out as the possible risk of lending increases, which will in turn be detrimental to the LIBOR rate.
This is however not the only form of funding. Banks fund loans and mortgages from retail deposits and the income derived from their existing loan book. Those banks that have continued to trade in recent months have managed to do so essentially on the back of retail funding, and the drive for investment business has been as aggressive as it was for mortgage business in recent years.
The drop in rates will mean that the income derived from borrowers will plummet, although banks will continue to grapple for investment business. Therefore the bank's profits will droop and their recovery will be made slower. As the banks fight for investment, the rates drop even below the LIBOR rate, meaning that the only way for banks to get liquid funds is through retail business. In that respect, LIBOR must then drop far enough to be attractive to banks in comparison with the cost of getting in retail business.
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!
As a nation, we are now all aware that LIBOR, or the London Inter Bank Offered Rate, is the rate at which banks borrow from one another, and is therefore a benchmark for how the lending markets worldwide should react.
The British Banking Association (BBA) takes the inter-bank borrowing rates from 16 contributor panel banks and looks at the middle eight of these rates (discarding the top and bottom four) and uses these to calculate an average, which then becomes that day's BBA LIBOR 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;
Now, as I have said, the drop in the interest rate would seem to be welcome news for all concerned. But it pays to look at this from the banks point of view. If they pass on the rate drop and it applies to someone who is in payment arrears then this could be detrimental for both the customer and the bank. For example say you have a customer who has monthly payments of 350 and is in arrears of 300 would not necessarily be perceived as a risk. Now say the rate is passed on and his monthly payment drops to 280. This means that the customer is more than one month in arrears. This creates a domino effect because with each passing month the debt is not being cleared and more is being owed. It soon gets to the stage where this will be seen as a bad debt and put in the hands of solicitors for collection. Not a good position to be in.
Banks who wish to lend to other banks at the LIBOR rate will be looking at the performance of the borrowing bank's mortgage book. This will inevitably have slipped with the decrease in rates, and will of course only slip further as more cuts happen in the future. As a result, banks will become more unwilling to lend out as the possible risk of lending increases, which will in turn be detrimental to the LIBOR rate.
This is however not the only form of funding. Banks fund loans and mortgages from retail deposits and the income derived from their existing loan book. Those banks that have continued to trade in recent months have managed to do so essentially on the back of retail funding, and the drive for investment business has been as aggressive as it was for mortgage business in recent years.
The drop in rates will mean that the income derived from borrowers will plummet, although banks will continue to grapple for investment business. Therefore the bank's profits will droop and their recovery will be made slower. As the banks fight for investment, the rates drop even below the LIBOR rate, meaning that the only way for banks to get liquid funds is through retail business. In that respect, LIBOR must then drop far enough to be attractive to banks in comparison with the cost of getting in retail business.
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:
Advice on mortgages from specialist Independent Mortgage Advisors help information and free to use mortgage calculators come to Mortgage Route
posted by Debt Consolidation Loan at
12:02 PM
0 Comments:
Post a Comment
Subscribe to Post Comments [Atom]
<< Home