"Banks defy Gordon Brown over new interest rate cut"

This article from the Times Online makes abundantly clear that UK banks do not plan to pass on any future base rate cuts by the Bank of England to customers. However it does not do a very good job of explaining why the bankers think they will not be sufficiently profitable if they add the same margin they get now to an even lower policy rate.

We have seen a similar problem here, but the reasons are pretty clear. Spreads on mortgage products have risen even as Treasuries have fallen, leading to only a modest improvement in borrowing rates. The reason here is that the volatility of interest rates has risen considerably, and that makes the consumer’s mortgage prepayment option more valuable, which increases the required spread.

From the Times Online:

High Street banks have told Alistair Darling they will not pass on any further interest rate cuts to consumers and businesses.

The banks have warned the chancellor they are “not charities”. They said they could not afford further to reduce mortgage payments and interest rates to businesses if, as expected, the Bank of England continued to cut rates as the economy fell deeper into recession.

Yves here. One could contest the banks’ view. They enjoy a unique role, protected by special licensing requirements, of taking customers’ deposits. And as we have seen, at least for large players, large banks are not permitted to fail. Losses are socialized. Darling may lack the authority, but he could counter by threatening to pull the banking charter of the non-compliant and tell them to make a go of functioning in those businesses that did not benefit from the state restricting entry. I am not familiar with the rules here, but a long time ago, I looked into what the consequences for a foreign bank operating in the US of giving up its US banking license. It would have had a big impact, meaning very significant revenue losses, mainly because they would have lost access to certain clearing and transfer services (in those days, Fedwire and Swift) which were very important to their home market clients. The impact would be far more significant for a native country player.

Back to the article:

The tough line from the banks will anger taxpayers, coming just a month after the government injected £37 billion into Royal Bank of Scotland (RBS), HBOS and Lloyds TSB to protect them from the credit crunch…

Bankers, who were summoned to a meeting at the Treasury on Friday morning, have told Darling that these latest cuts, which took bank rates to a 54-year low at 3%, represented a “line in the sand”…

During the meeting, which was attended by executives of eight major banks, it is understood Darling indicated that the three part-nationalised banks — RBS, HBOS and Lloyds TSB — would be placed under greater pressure to pass on any cuts.

When told that banks might not pass on Thursday’s rate cut to their customers, Darling said he would consider “prescriptive” measures to force the banks to do so.

“It was a difficult meeting,” said one banking source. “Right at the start the chancellor’s people thrust unflattering newspaper headlines under the executives’ noses.” A Treasury spokeswoman described the chancellor as “firm” with the banks at Friday’s meeting. “They all agreed to pass on all, or at least nearly all, of the rate cut to their customers.”

Interest rates are expected to fall below 2% next year. Some City economists believe there is a good chance of a pre-Christmas cut of one percentage point.

The bankers also repeated their concerns that Libor — the rate at which banks lend to one another and which broadly determines their ability to lend to mortgage-holders — remains substantially higher than the Bank of England base rate. However, the three-month Libor rate fell by 1.07 percentage points to close at 4.5% on Friday, the biggest fall since 1992.

Vince Cable, the Liberal Democrats’ Treasury spokesman, said: “The banks cannot be allowed to hold the consumer to ransom like this, especially now Libor is falling. If base rates fall, mortgage lenders must pass this on to their customers.”

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  1. Anonymous

    Barclays declined to “take the King’s shilling” and sold a big chunk of itself to SWFs. Arguably, BARC should be exempt from No. 11 armtwisting. I’m surprised that you think govt is politically (or morally?) entitled to decree coml bank lending rates, Yves.

  2. Anonymous

    As I matured, I came to the view that there is no such thing as “politically” or “morally” entitled. One either has the leverage to implement what one desires or one does not. Politics and morals are irrelevant.

  3. kevin de bruxelles

    If large banks are so critical to society that they are neither allowed to fail nor allowed to set their own lending policies, then perhaps the services provided by these banks falls into the same category as those provided by the police and military. In other words, the banks should stop being run to maximize profit and should instead be nationalized and run to maximize their benefit to society.

    This is, after all, the logical conclusion of all the government bailouts and subsequent micro-managing of lending operations.

  4. Anonymous

    I think that mortgage spreads will be permanently higher. We have learned that housing is riskier than we thought; thus, a slight to moderate in mortgages rates is necessary. If the UK politicians were wiser, they would accept that pricing risk properly is best for all: banks, homeowners, the government, and taxpayers.

  5. Anonymous

    You’ve got this wrong.

    The problem is compression between the base rate and deposit rates that are indexed to the base rate. A number of these deposit rates can’t be lowered any more, or at least not to an extent that matches the latest base rate decrease. So spreads compress when rates get too low.

    Base rate has nothing to do with pricing fixed rate mortgages or prepayment risk on them.

  6. Richard Kline

    The bankers have informed the citizenry—tacitly in the US and semi-publicly in this instance in the UK—that the interests of the bankers and of the citizenry do not coincied. The citzenry would do well to take this advice to heart . . . and put their own interests ahead of the bankers. The question is, are the sheeple capable of growing some teeth? Morals here are not irrelevant, but leverage is what determines who gets what, and for how long. The public authorities can have all the leverage that they decide to statutorily define. And the bankers have just defined themselves as a clique opposed to the interests of the citizenry. Ergo . . . .

  7. Marco

    kevin de bruxelles

    I agree with you 100% !

    AND there is another reason to nationalize banks (to start with the central bank, of course): because they CREATE money out of thin air via the fractional lending system.
    It is of the most clear evidence that the CREATION of money IS a public task BECAUSE the state is the one and only entity that has the power to enforce the LEGAL TENDER of the money itself paper money AND credit money).
    So, the state must also be the one and only institution to be allowed to create money (paper money AND credit money).
    The big crisis in which we all are at the present has made cristal-clear that NO private actor must be allowed to play a public task and – above all – to keep the profits of it and pass to all of us the losses.

  8. wintermute

    I agree with anon 3:07

    The credit crisis has proved one thing: morality in finance is out the window. Darling is right to kick the banks because they will happily kick their customers – anyway.

    I have been a customer of Barclays for 20 years and – but I would not recommend them – nor would I advise anyone not to use them.

    More importantly Barclays is the product of 300 years of bank mergers and acquisitions. This is acculumated wealth. Frequently I see the old Gibson Bank headquarters in Saffron Walden which Barclays acquired in the late 1800s. This was built up by hard work over long years. The real tragedy is that huge chunks of wealth accumulated by generations has been utterly squandered in a few years of ponzi/tulip foolishness. And the people to blame will golden parachute into comfy retirement. Fairness is dead too.

    Barclays not taking the “Kings shilling” is nothing to be proud of either.

  9. River

    Marco…Congratulations, you have discovered what the founding fathers of the United States said.

    At the current rate of change banks will soon be akin to public utilities and governed accordingly. Not an altogether bad outcome based on the recent activities of banks.

  10. Marco

    River said…
    Marco…Congratulations, you have discovered what the founding fathers of the United States said.

    Congratulations to the founding fathers of the United States, not to me !

  11. ruetheday

    “The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”
    –Lord Acton

    I am curious, however, whether the banks’ position is:

    We’re not going to expand our volume of loan creation and we’re keeping rates high.


    We are going to expand our volume of loan creation due to the rate cuts, but we’re going to keep our rates high.

    Two very different scenarios.

  12. joe

    Were I you, I might be getting worried.
    The dialogue on your turf is changing from the relationship between overall restructured tranches as a component of global diversified portfolio whatchamacallits, and on to something called the power to create money.
    The Lord Acton quotes and the Thomas Jefferson quotes are beginning to sound like a pen-filled clamor for monetary revolution.
    And this article is one of many that shows the exact reason why the i-waves are filled with such clamor.
    On the pages of NC.
    The basic problem we have to face is not that this is, or isn’t, the essential reality of the times.
    It is that it has been nobody’s job to prepare an exit strategy from laissez-faire’s final bubble and into the unfolding reality of the fallacy of the debt-money system that is THE underlying cause of our present situation.
    I believe it true that both the Chicago Plan economists of FDR’s brain trust and the Austro’s of the von Mises and Hayeks all agreed that we need an end to debt-money creation (fractional-reserve banking) and we need to turn to a 100 percent reserve bank lending system.
    The result of which is to mix Keynes and Friedman with the best, rather than the worst, of what each had to offer.
    Just a thought.

  13. elartistamadridista

    Don´t banks get a big chunk of their financing at fixed rates? If so, then if those fixed rates are well above the floating rates they are getting from mortgages it should hit their margins greatly.
    It´s not like if for every pound they lend at a floating rate there´s a pound borrowed at the same rate. There´s fixed rate borrowings and equity.

  14. ruetheday

    joe – The issue isn’t so much money creation (I used to think this way too) as it is maturity transformation. While banks are the primary sources of maturity tranformation in a financial capitalist economy, they are not the only source, and other sources are growing. Excess maturity transformation combined with excessive leverage is a recipe for disaster. 100% reserve banking and narrow banking could be part of the solution, but they’re certainly not the entire solution. There’s a great discussion on this topic going on over at Interfluidity right now.

    In the meantime, I’ve turned my focus to preparing for the huge wave of unemployment that’s headed our way. See http://www.de-grid.com/blog/ and start preparing now. Things are likely to get as bad, if not worse than they were in 1980-82 over the next year or so.

  15. Anonymous

    Not one saver of course has ventured on to this blog and it is they who might benefit from banks not passing on the cut. The assumption seems to be that the banks borrow their money from the government at the bank central bank rate, yet this is clearly not true.
    The interest paid by a borrower must be the interest paid to a saver plus an amount for the risk plus the banks profit. The bank can cut its profit but it can dod little amout the amount paid to investors taking the risk.
    The UK chancellor needs to talk to investors to accept a lower payment for taking risks. Basically the world has changed and borrowing now costs what it should have cost all along. Namely a few percent more than the central bank interest rate.
    I have no doubt the semi nationalised banks will be forced to run at a loss, but if that loss is too significant then we pay for it anyway. The only difference is that politicians are held in a better light than the banks.

  16. a

    Don’t know how much this is relevant, but for the longest time bankers were perfectly happy to lend at Libor + small x, where small x was their desired margin – because they all expected to be able to finance at Libor or less. Those days are gone. For the next ten years or so, banks will be adding on an extra spread to all those deals, because over the past year and a half, a lot of people have got killed lending at Libor + small x, and having to finance themselves at Libor + big y. The break-down of Libor is going to have real consequences for lending and how much banks are willing to lend at, and for a long time.

  17. SlimCarlos

    @anon (11:16)

    >> The UK chancellor needs to talk to investors to accept a lower payment for taking risks.

    Those who deposit money in banks are hardly "investing", especially if the banks in turn refuse to lend the money out for productive purposes. And what risks does the poster refer to? Every bank now has now been implicitly backstopped by taxpayers. It is galling to be asked for a return while we foot the risk.

    A more apt term to describe this phenomenon is "hoarding" and that is the problem we're having right now — folks are hoarding their cash to the benefit of no one and the detriment of many.

    By cutting rates the gov'ts are trying to discourage hoarding but as is pointed out here, this ain't working. The stiff prod of monetary policy is in fact a wet noodle. Stronger action is needed.

    Devaluation. More. Faster. Please.

  18. doc holiday

    Thought I'd toss this in here:

    Commentary: Why there's a crisis — and how to stop it

    "I like to use a salad analogy. Before the last decade, bankers simply lent in the form of syndicated loans. But with the huge expansion of the global economy in the 1990s, which produced an ocean of new capital, the bankers came up with an idea called securitization. Instead of making simple loans and holding them until maturity, a bank collected all its loans together, then diced and sliced them up into a big, beautiful tossed salad.

    The idea was to sell (for huge fees) individual servings of diversified financial salad around the world. The only problem: under an occasional piece of lettuce was a speck of toxic waste in the form of a defaulting subprime mortgage. Eat that piece of salad, and you're dead. The overall salad looked delicious, but suddenly global investors were no longer ordering salad. No one knew the location of the toxic waste. This distrust heightened when global interest rates began to rise.

    So what does this salad boycott mean for the future and why have financial markets collapsed so brutally"

    >> That was a little stale, but the metaphor is very good with ABS, because corporations and banks will have less future value, because things like auto sales will decline and the ability to package "salads" will be like selling tainted spinach to a market that wants to stay away from toxicity. Hence, lowering rates and taxes to instill confidence, is like offering bags of spinach at 30% off and hoping that there will be investors out there willing to eat potentially tainted mixes of re-packed waste products that should be in the dump rotting.

    The death of ABS/derivatives will crash wall street and force the re-invention of capitalization, which I assume will be linked and backed in the future, by more homegrown-like investments that are easily understood and tangible.

  19. luther

    richard: “The citzenry would do well to take this advice to heart . . .”

    and using river’s transformation in another post, perhaps the citizenry only now has power as a consumer…a nonconsuming consumer.

    in this case, the thing being consumed is that whopping 0.5% interest the big banks are giving the deposits of the citizen consumer.

    i/o/w if the citizenry wishes to take action, they can, but only now as consumers, by taking their deposits out of bancos TBTF and into smaller ones with adequate stability.

    …starve them on both ends…

    this is not advocating withdrawing from the banking system, but only from those who have ‘defined themselves as a clique opposed to the interests of the citizenry’.

    this is the legal right of the citizen/consumer.

  20. luther

    then there's always the radical possibilities:

    vlade over @ bsetser's blog shared this one a while back–

    they seem to practice MT that an austrian might even appreciate, plus they're federally insured.

    also, http://www.kiva.org/community

    cool thing is you can create a team and lend as a group, thus lowering your individual risk to 1 borrower.

    and grameen just expanded to queens:


    but right now, they can only accept donations not deposits.

    and if you wanna see something really wacky, watch muhammed yunus & michael milken together on charlie rose:


  21. Anonymous

    Hey slimcarlos (No relation I can safely assume). Why don’t you start the the world’s first Anti-Hoarding Bank,

    a) no one will be allowed to receive interest on deposits

    b) loans will be made direct from a compulsory allocation of taxpayer funds as ordered and approved by the Slimman

    c) Risk regulated according to SLIMCARLOS II principle what I don’t see ain’t there.

    The people are dying for this sort of financial innovation.

    I, for one, would not invest 10c.

  22. john bougearel

    Kevin is right, banks should be run like a utility, to maximize benefit to society. Where we go wrong in our thinking is that we think we need private banks to fulfill this utilitarian function for society. We do not need private banks to do that, and believing that we need them is fallacious and should be dispelled and demythologized.

    We can simply set up a a govt-owned bank to do all the lending a society or economy requires. It has been done before with the RFC in the 1930’s.

  23. Nick von Mises

    Oh my word these comments depress me. Devalutation! Screw the banks! Enlarge the government! Give the control over commercial money creation to precisely the clowns who ruined base money creation!

    This is the real Shock Doctrine – Disaster Socialism. Backed by the most spurious of economic pseudo-reasoning

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