01 Aug 2009, Nick Sawyer, Risk magazine
Banks and regulators seem to be caught between a rock and a hard place. On the one hand, interest rates across the globe are sitting at record lows, while banks have received multi-billion dollar bailouts courtesy of the taxpayer. On the other, businesses and households say they still face difficulties accessing credit, while lending rates in certain countries have ballooned.
This has been leapt upon by the press. In the UK, banks have been pilloried for charging excessive margins, while the Chancellor of the Exchequer, Alistair Darling, has warned UK banks on several occasions to increase the supply of loans at affordable prices.
There is a bit of an inconsistency here, though. While banks - particularly those in which the government has a stake - are being asked to increase lending, regulators are demanding financial institutions hold more capital. Meanwhile, much of the world is in the grip of recession, unemployment is rising and defaults on loans are mounting. Having underestimated the credit risks posed by certain borrower segments in the past, financial institutions are unlikely to make the same mistake so quickly. Another major problem is the continued shutdown of the securitisation market. Without a facility in which banks can lay off risk and free balance sheets, there is a finite capacity to make loans.
Banks need to repair battered balance sheets, so it is perhaps understandable - although not necessarily acceptable - that margins on many loan products have increased. However, banks also need to be prudent in their lending decisions and ensure they are sensible in pricing in credit risk, in what has become the worst recession in living memory. Higher capital requirements are, again, prudent in the current environment, but it does mean banks will eventually reach a limit to the amount they can lend without the ability to lay off risk through securitisation.
Even taking this into account, many politicians argue banks could do more. That may be so, but some contradictions still need to be resolved. Should banks look to lend more at lower rates? That is likely to require a resumption of the securitisation market, although with checks in place to dampen the exuberance that eventually led to a deterioration in underwriting standards in 2006.
Another alternative touted by some is a return to more traditional banking, where bank lending is constrained by the size of their balance sheets and the capital they have to hold against these assets. Throw in conservative credit risk measurement, and it would probably entail higher interest rates than borrowers have been used to.
Many aspects of the banking model are in flux. It is not yet clear which way the pieces of the puzzle will fall, but it is difficult to envisage a large-scale increase in lending at lower interest rates without some sort of functioning securitisation market.
Nick Sawyer, Editor.