Thursday, 2 June 2011

Feckless spenders, prudent savers and the Bank of England

There is a myth going around that the low Bank of England base rate (currently 0.5%) benefits "feckless spenders" at the expense of "prudent savers".  Quite apart from the value judgements inherent in those labels, this is completely untrue and very unfair to both the Bank of England and borrowers.  Yes, savers are getting a raw deal at the moment. But that's not because of anything the Bank of England has done.  It's all to do with the commercial banks.

Interest rates to many unsecured borrowers are currently sky-high, having rocketed since the financial crisis. Typically these are people who are struggling a bit - they are maintaining their minimum payments and maybe a bit more, but they have a lot of debt and rarely pay off anything completely, so they are regarded as high risk and therefore hit with high rates. Interest rates for more creditworthy individuals are much lower, but that is because they are seen as a less risky proposition and therefore a good lending prospect - and banks really do like lending as long as the risk is low, as I've explained in previous posts.  So interest rates for people who don't really need credit are low in order to attract them.  These are the headline rates that are advertised by the banks.  The much higher rates actually charged to people with dodgier credit records are kept well under wraps in case it puts off the low-risk customers the banks really want to attract.  Now, I'm not criticising the banks for charging different categories of customer widely different rates. That is normal market rate-setting behaviour.  But it has absolutely nothing to do with the base rate. 

Mortgage rates are still low, and we are told that that is because the base rate is low, but I doubt it. I think it is because the housing market is still overvalued, so the value of collateral is high. If house prices fall significantly (as Morgan Stanley predicts), mortgage rates will shoot up irrespective of what is done with the base rate. This is because more people will be in negative equity, so mortgages will be partially unsecured, which increases the risk.  Also, difficult economic circumstances are already increasing the rate of mortgage defaults and repossessions, and this will also drive up mortgage rates.  Again, the rates really have nothing to do with the base rate.

On the savings side, savings rates are currently below inflation. Admittedly Libor is rising a bit because of the Greek disaster, but it is still below 1%, and as I said above, unsecured lending rates are sky-high for a lot of people. So for financial institutions to be paying less than inflation on savings is disgraceful.  Savings we lend to banks are put at risk in order to earn a return, and we pay through our taxes to protect them.  If banks aren't even going to protect our savings against inflation, why on earth do we lend them the money? They have no right to our money. They should pay us a proper rate of return for lending it to them.  And if they won't, then we shouldn't lend it.

I want to make it clear, once again, that I am not blaming the banks for commercial rate-setting behaviour.  It is perfectly reasonable for them to try to pay savers as little as they can get away with. But nor should the Bank of England's low base rate policy be blamed for the fact that savers are losing out.  That's a myth fostered by commercial banking to distract attention from the real issue.

The base rate is the rate at which the Bank of England lends to banks, and it governs the interbank lending rates. The rates commercial banks offer to savers and charge to borrowers have nothing to do with this. Banks are free to set whatever customer lending and borrowing rates the market will bear, irrespective of the base rate. They are currently choosing to set very low savings rates and high borrowing rates in order to recapitalise their balance sheets and maintain their RoE in the face of higher capital requirements.  And because there is insufficient competition in the banking sector - and in my opinion there is a bit of price-fixing going on as well, disguised as a mythical "tie" to the base rate - they can get away with this because there is nowhere else for savers or borrowers to go.

So feckless spenders and prudent savers are all in it together, really.  Along with the Bank of England.  But instead of pointing the finger at the profiteering banks and demanding that the government take action to improve competition and eliminate price-fixing, these groups are fighting among themselves and blaming each other. And the banks rake in the money.

2 comments:

  1. And the previous government created this situation and in fact encouraged Lloyds TSB to take over HBOS. Now all that is being unraveled. Dontcha just love politicians and their crass stupidity?

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