Lending a helping hand
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It has been a tumultuous few weeks for UK retail banking. The government published its White Paper on banking reform in June, with a road map for implementation of the recommendations made by the Independent Commission on Banking. These will remove the risk of taxpayer bail-outs for our largest banks by separating their investment and retail banking businesses.
It was welcome that an exemption is to be applied to smaller deposit-takers with less than £25bn, as this excludes the vast majority of mortgage lenders from the scope of these changes. Their focus in the next few years can continue to be serving their mortgage customers rather than reshaping their group businesses.
However the White Paper and legislative measures will be an ongoing distraction for major players in the market, albeit a price that needed to be paid to ensure long-term market stability and to avoid future systemic shocks.
On the same day as the White Paper was published, in complementary speeches at the Mansion House dinner, the chancellor of the Exchequer and governor of the Bank of England announced a joint initiative to ensure that UK banks have sufficient liquidity in the event of worsening impacts from the eurozone crisis.
More focused on the mortgage industry was the separate announcement of what looks like an innovative ‘funding for lending’ scheme to replace previous bilateral commitments by the large banks through Project Merlin.
How will it work? At the time of writing, details were limited. It was suggested that the scheme could be launched within weeks and that, to be successful, it would need to lead to about £80bn of activity to support businesses and consumers. At first sight, the terms look advantageous – cheap funding for lenders for an extended period of several years at rates below current market rates, with the expectation that this benefit would be passed on to customers.
Why is the scheme necessary? The governor highlighted the risk that as businesses and households batten down the hatches to prepare for the economic storms ahead, it undermines the UK’s growth agenda and long-term strategy for resolving the current economic difficulties. A credit freeze could worsen if the eurozone situation deteriorates, for example on the exit of Greece.
The funding for lending scheme is clearly designed to avoid a worsening credit crunch in the UK. The warning signs were also reinforced by the first report of a negative monthly net mortgage lending figure for the banking sector, announced at the end of June by the British Banking Association. With a number of banks scaling back their new business and focusing on other areas rather than mortgages, this may become a feature of the market unless there is a determined government-backed intervention.
The governor in his speech highlighted that a cause of much of the current uncertainty was the problem of solvency, not liquidity – the inability of current debtors to repay their debts, and the failure of some creditors to recognise future losses in their balance sheets. He said: “An honest recognition of those losses would require a major recapitalisation of the European banking system.”