Questions on Bank Lending during 2008

Readers Question: 1. The government puts a lot of money into banks who over-lent funds. So why are the banks still lending out money for mortgages?

Many banks overstretched themselves. They lent a high % of their assets. For example, Northern Rock’s asset to loan ratio reached 44%. It means for every £1 of loan, they had 44p of assets.

Because of the credit crunch and the difficulty of raising money on the short term money markets, banks have drastically cut back on lending.

Firstly, it is important to bear in mind how much bank lent to consumers  in the past decade.

In 1997, banks lent £32bn. In 2007, that had increased to £117bn. What we are seeing now is a drastic reverse as banks looks to attract savings and reduce availability of mortgages. This is necessary for banks because they can’t raise funds on the money markets like in the ‘boom years’

They are still lending some mortgages because they are profitable for the bank in the long run. However, they are wanting mortgages with bigger deposits. 125%, 100% mortgages no longer exist. 95% mortgages are much more expensive.

The government is concerned if lending contracts too much then it could cause a serious recession. Without mortgages, house prices have plummeted. Without loans to banks, business investment will dry up. Therefore, the government are hoping that the cash injections will enable lending to continue. Lending is important to maintain the stability of the housing market and wider economy. In announcing the package today, Gordon Brown said he had ‘gained guarantees the banks would enable mortgages to be made available.

Conclusion

Yes, banks are trying to improve their balance sheets. This is why loans and mortgages are becoming harder to get. However, lending is the core aspect of bank business, therefore, they want to maintain some lending because this is essential to their long term business. The government wants to maintain liquidity in the banking system so the system of credit is maintained.

2 thoughts on “Questions on Bank Lending during 2008”

  1. The banks essentially want to get out of their overlent positions now, calling in loans to pay back their commercial paper. Just how much total amount is involved? If we know this then we have some idea just how big the total “quantitative easing” programme is going to have to be. I make it maybe £500bn – can anyone get closer?

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