Tag Archives | banks

Labour plans for bank reforms – UK Bank market share

Readers Question: would you be able to comment on what the Labour party’s latest proposal to break up the banks to create competition? I can see some reasons that relate to safe guarding possible failures of large banks which can prove costly if the government are needed to bail them out. However, in terms of helping to stimulate economic growth, would it help or is it like shuffling a deck of cards? I would greatly appreciate hearing your opinion on this.

Labour bank reforms include:

  1. A cap on the size of banks’ market share; this will involves splitting up large banks, such as Lloyds and RBS
  2. The introduction of two new challenger banks with an 8% market share.
  3. Refer the issue of banking competition to the Competition and Markets Authority (CMA), within one year of being elected.

Motive for bank reforms

  • The UK banking sector has become more concentrated in recent years. This has created less competition and more market power. If the government is able to reduce market concentration and increase competition, then they hope that consumers will benefit from more choice and greater price competition. If the banking sector becomes more competitive, the theory is that it will put downward pressure on the cost of borrowing, and upward pressure on saving rates.
  • The OFT found in a review of the current account market that, while the share of the four largest providers fell from 74 per cent in 2000 to 64 per cent in 2008, it then rose to 77 per cent in 2010.

bank-marketshare

  • A report by Bain & Company,¬† showed that the market share of the top six banks together account for 91% of retail deposits. The problem of high market concentration of retail banks is that market power leads to dominance in related financial products, such as mortgages, loans and overdrafts.
  • Reducing the size of banks helps to deal with the issue of banks which are too big to fail. After the credit crisis, the government had to bail out large banks, at a cost to the taxpayer. Reducing the size of banks means that any bailout will be less costly. Continue Reading →

US housing market main cause of credit crunch

Readers Question: The money that brokers/banks etc were making from selling on the mortgages to investors encouraged the sub prime debacle. Which I understand. The bit I am struggling with is what started the fall in the US housing market. If the banks slowed down on their lending that would surely just cause a slow down in new mortgages which would result in a slow down in the housing market.

It was in the US housing market that the real problems emerged. It was mortgage defaults that caused the biggest hole in bank balance sheets.

In the boom period, mortgage lending had been very aggressive. Mortgage companies made new mortgages to

  • People with bad credit,
  • Mortgages with high income multiples,
  • Mortgages with low introductory offers – low interest rates for first year, then rising interest rates.

Basically, people were being given mortgages, who in ordinary circumstances wouldn’t be able to afford their mortgage payments. A fundamental problem was the lack of satisfactory regulation in the mortgage market. It was kind of hoped US housing prices would keep rising so that if people couldn’t afford mortgage payments the house could just be sold.

However, when US interest rates rose in 2005 and 2006, many US homeowners started to default on their mortgage payments, and homes began to be repossessed; as a result banks lost money. Mortgage defaults also spread across the financial system because these mortgage debts has been repackaged (sold on) to other banks.

This is when the credit crunch really started to occur, banks balance sheets were adversely affected by mortgage defaults of US homeowners. Because banks and other financial institutions lost money, they also had to cut back on lending. This led to fewer people buying houses and caused an even bigger drop in house prices. As house prices fell, banks lost more money on mortgage defaults.

See also: Boom and bust in US housing market Continue Reading →

Policies to Increase Bank Lending

In a previous post, we saw how bank lending in the UK fell during the credit crunch, contributing to the length and depth of the recession. Because of this the Bank of England and Government have sought to try and increase bank lending – in order to help stimulate economic growth.

m4 lending

Fall in bank lending.
These are some of the different policies that have been tried.

1. Cutting Interest Rates.

interest-rates
In March 2009, the Bank of England cut interest rates to 0.5%. Lower interest rates makes borrowing cheaper. This should increase the demand for bank lending as firms and consumers are more willing to borrow rather than save. In normal circumstances, a cut in interest rates probably would increase bank lending.

Continue Reading →

Bailout for Mortgage Companies

Yesterday, the bank of England¬† offered a scheme to bailout the banking sector by offering to exchange ‘unpopular’ mortgage debt for government backed securities.

The money markets have struggled since last summer and the American subprime crisis. This has led to a shortage of funds for mortgages and increased cost of mortgages.

I wrote an in depth analysis here: – Bank of England Bailout for Mortgage companies.

It is not certain how successful it is going to be. Abbey announced this morning that they will increase their mortgage rates anyway.