Cautious banks ‘are hindering recovery’

May 1 2008 by Iain Laing, The Journal

THE banks behind the lending boom which came to a spectacular end last summer are now hindering the recovery of the financial system by being too cautious, the Bank of England has warned.

Lenders are so fearful of further credit crunch losses that the return of confidence to markets is being hit, according to the Bank’s latest Financial Stability Report (FSR).

Sir John Gieve, the Bank’s deputy governor in charge of financial stability, said markets were facing a “protracted and difficult” adjustment following the end of the credit boom.

He said: “The pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals.”

While some credit tightening was “desirable”, the conservatism over losses on mortgage-backed investments hit by the crisis is causing concerns over the resilience of banks, pressure in money markets and reduced credit availability, the report said.

And the investors who would usually come in to buy the discredited assets at knock-down prices are being hampered by a lack of funding, the FSR added.

Borrowers and would-be homeowners across the country have also felt the strain of the new-found caution among lenders as banks hike up the cost of lending and demand bigger deposits at a time of rising inflation and falling house prices. Mortgage approvals fell to an all-time low in March – 44% below the previous year – as the lending taps run dry, according to Bank of England figures this week.

The report called for higher capital buffers among banks to strengthen balance sheets and deal with sudden downturns in markets to help restore stability.

This would cause less damage than a “self-defeating” clampdown on lending which would slow the wider economy, the Bank said. Some banks have already begun this process. Last week Royal Bank of Scotland called on shareholders for £12bn, while on Tuesday Halifax Bank of Scotland unveiled a £4bn rights issue. Although the FSR predicts the gradual return of confidence over the coming months, it said the financial system was still vulnerable to risks.

These include exposure to commercial property companies in a declining market, another banking crisis to follow those seen at Northern Rock and US bank Bear Stearns, and high levels of debt among households faced with falling property prices.

“Those who bought in recent years with high loan to income multiples and/or high loan to value ratios will be particularly vulnerable to further shocks to their disposable income, such as higher inflation or unemployment,” the report said. The Bank called on lenders to supply more regular and consistent information over their exposure to complex financial instruments, and to take a uniform approach to assessing write-downs. The central bank stepped in last week with a £50bn plan to help tackle the lack of confidence among lenders by allowing them to swap their riskier investments for Government bonds in order to strengthen their balance sheets.