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Why banks won't lend

• Robert Peston
• 9 Sep 08, 07:40 PM

How much of banks' current reluctance to lend is determined by their reduced ability to raise funds from wholesale markets and how much by their perception that the risk of lending has increased?

This matters, because it will determine whether the Government is wasting its time in looking for ways to encourage banks to lend more for mortgages, for example.

Or to put it another way, there would be little point in the Treasury using taxpayers' money to persuade global investors to end their funding boycott of the British banking system, if our banks were not to transmit those funds to cash-strapped companies and individuals.

Quite an important clue to the answer is given today by new Bank of England figures on average interest rates charged by banks for mortgages and for unsecured personal loans.

The first relevant fact is that the Bank of England's policy lending rate has fallen by three-quarters of a percentage point over the past year.

And that has not been passed on in full by most banks for most loans.

Thus last July the average monthly interest rate for two-year fixed rate mortgages with a requirement for a 25 per cent deposit was 6.07 per cent. In August the same loan was priced at 6.08 per cent.

Which is so close as to make little difference.

Also, arrangement fees for such loans have risen, so the overall cost of the loan has gone up.

That said, there has been a fall in the cost of variable rate mortgages over the same period, from 7.44 per cent to 6.92 per cent - or a bit less than the drop in the Bank of England's policy rate.

But here's one of the most dramatic changes: in July 2007 a two year fixed rate mortgage covering 95 per cent of the price of a property carried an interest rate of 6.33 per cent; from May, the Bank of England stopped publishing the cost of such loans, because most banks had stopped offering mortgages that required such small deposits.

What's preventing the full reduction in the Bank of England's policy rate being passed on to us?

In part it's that banks simply can't obtain the funds to lend from wholesale markets, or are being charged considerably more than the policy rate when they can obtain these funds.

That's the classic credit-crunch effect.

But there's also a strong element of banks' deciding to become more averse to risk - you can see that in the disappearance of high loan-to-value mortgages.

Here's the significance of what Graham Beale of Nationwide said to me yesterday. When he made his prediction that that the peak-to-trough fall in house prices over the current cycle would be 25 per cent, he was signalling that Nationwide wouldn't dream of providing 100 per cent loan-to-value mortgages.

Nationwide is demanding big deposits from its customers, precisely because it thinks house prices are falling.

So like all banks its lending policy manifests a growing aversion to the risks in the housing market.

The Bank of England's data shows that this new risk aversion has been even more pronounced in the provision of personal loans.

Over the past year, the average interest rate on a £5,000 loan has risen by more than three percentage points to 12.37 per cent and that on a £10,000 loan has increased by two percentage points to 9.42 per cent. Overdraft and credit card rates have also inched up.

This shows that banks are factoring in the impact of an economic downturn on the ability of their customers to keep up the payments - and never mind that the banks are making their nightmares a reality, that they are exacerbating the downturn, by restricting credit and making it more expensive.

The banks have their eyes wide open when increasing these interest rates. In the past few days, the chief executives of two of our biggest lenders - Andy Hornby at HBOS and Beale at Nationwide - have both told me that it's imperative they charge higher rates to reflect what they perceive as the increased risks of lending.

Bottom line?

Even if there were a sudden increase in the availability of wholesale funding, our banks are not going to start lending 100 per cent mortgages to first time buyers or providing unlimited funds for buy-to-let landlords.

The shortage of credit will persist, because banks only want to lend to a minority of borrowers who are rock solid.

In other words, the Treasury's agonising about whether to use taxpayers' money to underwrite the mortgage market may be fatuous - in that banks wouldn't lend much additional money even if they had it.

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