Bank Lending Standards

Readers Comment What is so infuriating is that Gordon Brown chose to give the banks huge sums of money to help lubricate the economy, only to forget to put in a clause compelling them to lend it! (from: Why are banks not lending?)

It is a difficult issue. Part of the problem in the run up to the credit crunch is that banks were lending too much. They were lending irresponsibly.

  • e.g. mortgages 6 or 7 times incomes.
  • 100% mortgages.
  • Banks were borrowing money on money markets to lend long term mortgages.
  • Banks reduced their liquidity ratio and hence their reserves.

It was this willingness to run down bank reserves that was a big factor in causing an asset bubble and the ‘credit crunch’ Banks were so highly indebted that there came a point when they no longer wanted or were able to lend to each other. This caused the freeze in bank lending and was a reason why banks like Northern Rock had to rely on finance from the government – There was no private bank who would continue lending them the money they needed to remain solvent.

This credit crunch caused a dramatic fall in bank lending and started to effect the real economy. Firms couldn’t take out new loans.

The government have injected liquidity into banks through buying shares (in the case of part nationalised banks like Bradford & Bingley) and also through quantitative easing.

Despite the injection of government cash, lending is still far from normal. But, it must be remembered

  • In a recession, the risk of bankruptcy is greater.
  • Banks are trying to improve their balance sheet after lowering their liquidity ratio during the boom years.
  • Falling house prices increase the chance of negative equity which is why banks are wanting a larger deposit ratio.

The difficulty is we want banks to return to ‘normal’ lending criteria without returning to unsustainable types of lending.

After the failure of banks to judge long and short term economic trends, it may appear the government would have better judgement in deciding who to lend and how much. But, this is not without difficulties.

There are many businesses struggling from liquidity constraints; these business probably deserve bailing out much more than the banks. But, again the problem is the bank bailout has proved so costly, the government have little room for manoeuvre in financing other businesses.

It is not fair that banks get bailed out whilst many other businesses go bankrupt. But, unfortunately, we have to bite the bullet and do unpalatable things. Why Banks need bailing out.

2 thoughts on “Bank Lending Standards

  1. Surely the key difference between the banks and other firms is their broad base. If a bank goes bust not only do you lose those jobs but also, all the firms borrowing from that bank are in deep trouble and hence create further job losses across many industries, creating negative spiral throughout the whole economy. So whilst morally the banks may have been at fault the case for saving them is greater than general motors or vauxhall for example.

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