Banks Reluctant To Take On Risky Customers
Despite the good news coming from the US with the bail-out of two major mortgage banks, lenders in the UK are still reluctant to lend. Why are they so nervous? There are factors that suggest that the credit crunch has some way to run yet, before lending is freed up again.
We know that banks are seemingly more reluctant than they used to be to lend money to would-be house buyers. This is evident in higher mortgage interest rates (in relation to the Bank of England base rate), higher fees for mortgages, and the demand for higher deposits.
The credit crunch has hit the banks and the knock-on effect has been to hit consumers. Money for mortgages is more difficult to come by. Just as Fannie Mae and Freddie Mac were bailed out in the US, so that is followed by more potential bad news concerning US bank Lehman Brothers, with the Korea Development Bank pulling out of a possible deal. The credit crunch just won’t go away.
Banks are trying to build up their cash reserves which is why they are not passing on cuts in interest rates to their customers in full. They want to avoid the situation that Northern Rock got itself into – that of not having enough liquidity (ready cash) to support their day to day operation.
However, there is more to building up cash resources in banks’ reluctance to lend, and higher mortgage costs. The plain fact is that they are nervous of taking on risky business.
It was the US banks’ alacrity to lend to risky borrowers that has caused this whole situation in the first place. Lending money to sub-prime borrowers at low interest rates back-fired badly when interest rates started to rise again. The borrowers could not afford the repayments.
Fair enough, therefore, that banks should try and avoid sub-prime borrowing in the future. The problem is that banks have widened their definition of risky borrowers. With house prices going down, anyone borrowing at 100%, 95%, 90% loan-to-value has become a risk, which is why most of those high loan-to-value mortgages have disappeared. With the latest Nationwide forecast of a 25% fall in house prices, anyone borrowing at 75% may be seen as a risk, because if the borrower defaults on payment, the bank could then be left with a property worth less than the mortgage.
There is some way to run yet, before the credit crunch is over, and lending is truly freed up again.
