The issue of lenders’ liquidity is set to have serious implications on new mortgages and the housing market in the next couple of years, in light of the withdrawal of stimuli measures and new regulations resulting from the credit crunch.
The upcoming Basel III proposals, due to be finalised this year, are designed to improve banks’ ability to withstand shocks by boosting capital and reducing dependence on short-term funding.
The Bank of England’s Special Liquidity Scheme, which for the last two years has injected £165bn into the financial system, is being gradually withdrawn and will end completely in January 2012.
The withdrawal of liquidity and the requirement for banks to strengthen their balance sheets will affect how easily and at what cost buyers get access to finance, and risks stalling any recovery in the housing market. Crown’s position is that poorly timed regulatory squeezing of lenders poses a large risk to what is a very weak recovery. Though it is important lessons are learnt from the excesses which caused the financial crisis, considered lending needs to continue in order to sustain growth in the economy and in the housing market.
Liquidity: the economy needs it; businesses need it; lenders need it. The liquidity crisis of two years ago brought the banking system to its knees but for massive government intervention. Unbridled leveraging and weak underwriting practices resulted in a huge transfer of capital from governments and hence taxpayers to some of the largest players in financial services.
Two years on, economic conditions have improved but remain fragile and the risk of a “double-dip” can still not be totally discarded. Balance sheets are in better shape and credit is beginning to flow again, though very cautiously. There has been a gradual improvement in the availability of mortgages, with lending for house purchases rising for the past 11 consecutive months. 15% more home loans were issued in May 2010 than May 2009.
This positive run is set to end though and the Council of Mortgage Lenders has already stated it does not expect any further pick up in activity in the mortgage market this year. Liquidity is at the heart of the issue: banks, economic commentators, and virtually everyone else is worried that the credit markets may start to seize up again soon.
This is because the institutions at the top of the pile the banks, whose lending to businesses and each other is essential in keeping the economy growing are becoming nervous over major changes on the horizon. Accommodative policies have driven a sharp rise in earnings among financial institutions but as the stimuli wear out and are wound down and regulators look to ensure “this never happens again”, the taps may soon be switched off.
After spending with little restraint to “save the system”, governments are now faced with the bill. In the UK, the newly elected coalition government is on an “austerity drive” to try and reduce the UK’s huge deficit resulting from the crisis. The measures will translate into increased taxes, higher unemployment as government employees are let go, and little appetite for spending. As a result, the government is gradually peeling off the financial band-aid used to get the banks through the credit crunch.
The Special Liquidity Scheme has been one of the Bank of England’s flagship initiatives to get the economy moving, and has, for the last two years, injected £165bn of liquidity support into banks, allowing them to heal and very tentatively return to their role as lenders. This support is gradually being withdrawn and was recently confirmed to end altogether in January 2012. As at the end of June, banks had debt of about £800 billion to refinance through 2012. They need all the liquidity they can get, even if some of that liquidity comes from lending less.
As a result of the credit crunch, banking regulation is being introduced to compel banks to set aside billions of pounds of extra capital, so they are better able to cope with any potential future crises.
The Basel III proposals, the finer details of which are currently being thrashed out by leading banks and global regulators, will seek to increase banks’ capital cushion and improve their overall liquidity. Regulators believe that reliance on short-term funding and insufficient downside protection built into the balance sheet are at the core of the most recent crisis.
These proposals will not be without wider consequences. Higher capital requirements mean less capital available to lend. That drives both availability and cost of borrowing: fewer borrowers will have access to funding and at substantially more onerous conditions. The Institute of International Finance has calculated the potential cost of the Basel III requirements and claims they could cut economic growth by 3% in the US, the Eurozone and Japan over the next five years. Some critics dispute this figure, but the true cost will only be known once regulation has been introduced and the dust has settled. It is anticipated that the regulations will be implemented by late 2012.
For the continued recovery of the housing market and the wider economy, it is vital that the banks start lending again and increase the availability of mortgage funding. Only recently have credit markets started to free up, and they remain incredibly sensitive.