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.”