Lenders not passing on low base rate

20 September 2010 | By Natalie Thomas

The report was compiled by Richard Button of the Bank’s Financial Institutions Division and Silvia Pezzini and Neil Rossiter of the Bank’s Monetary Assessment and Strategy Division.

It says that during the recent financial crisis the base rate has reduced sharply, but in general the interest rates charged on new lending did not and in some cases rose.

The report blames this on lenders’ funding costs, credit risk charges and a residual, which refers to the operating costs and the mark-up lenders apply to the mortgage.

The report says a main factor included in the residual is the mark-up that lenders charge over their marginal costs, which ensures that each loan extended generates an expected rate of return.

It says a larger residual is consistent with lenders increasing mark-ups over marginal costs for new lending, which may reflect a need to build higher capital levels within the banking sector.

The report says: “During the financial crisis, funding costs rose sharply and the residual became negative.

“It is possible lenders were surprised by the persistence of higher funding costs and so may have been slow to update the pricing of new mortgages. Since early 2009 the residual has increased markedly.”

The report says lenders are seeking to rebuild net interest margins, in part through a higher mark-up on new lending.

It says: “This is consistent with lenders rebuilding capital through retained earnings, an important part of the ongoing adjustment process for the UK banking sector and a factor that should ultimately lead to lower funding costs.”

The Council of Mortgage Lenders has welcomed the report and says it clearly makes the point that the factors influencing pricing are many and complex.

Bob Pannell, chief economist at the CML, says: “The Bank sets out a clear explanation of the influences on the pricing of new lending. Two particularly striking observations leap out.

“First, the pricing of new secured lending is emphatically downwards compared with the price of new unsecured lending which is emphatically upwards.

’Second, the fact that lenders are seeking higher returns on new business is a logical response - even a desirable one - that should help lenders rebuild capital, improve investors’’ perceptions, and ultimately bear down on funding costs over time.”
 

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