Business

Bank of England says lenders 'not passing on rate cuts'

Headquarters of HSBC and Barclays in London
Image caption Banks are looking to rebuild their capital reserves

High Street banks have not been passing on base rate cuts in full to household borrowers, a report has found.

The interest rate charged on some loans has risen, the article in the Bank of England's quarterly bulletin found.

Much of the divergence was due to the borrowing cost of banks themselves - which has not fallen as steeply as base rates - and higher charges because of higher default risk.

However, a large part could be down to banks pricing in fatter profit margins.

Bigger markups

Image caption The cost of a new unsecured loan has gone up, despite the Bank of England cutting base rates

The Bank of England cut base rates - the rate at which UK banks can borrow overnight from the central bank - from 5% to 0.5% in response to the 2008-09 financial crisis and recession.

However, interest rates on secured loans to households - which includes mortgages - only fell about 2.5% since mid-2008, to about 3.75% currently.

And the typical interest rate on unsecured loans - such as personal loans and credit card debt - rose during the same period from about 8.5% to nearly 11% currently.

This means that banks have been charging a much bigger markup on their lending to individual borrowers compared with the Bank's benchmark policy rate.

Much of this increased mark-up was explained by the rate at which banks can themselves borrow over the longer term.

This "funding rate" has not fallen as quickly as base rates, because banks are perceived as riskier, and because base rates are expected to rise in the future.

Banks have also had to charge more because of higher losses on loans due to higher default rates by borrowers - a particular problem for unsecured loans where the bank cannot rely on any collateral.

Bigger profits

However, a big part of the difference was an unexplained "residual" factor in the Bank's number-crunching analysis.

This residual had been negative up until mid-2008, suggesting that banks were so aggressive during the latter part of the credit boom that they were actually lending at an expected loss.

Then after the financial crisis, it turned sharply positive - meaning banks were charging much more than is justified by their funding rate and by their expected losses on bad loans.

In its report, the Bank of England was cautious about how to interpret this residual, and offered several possibilities:

  • banks charging more profits so they can build up their capital reserves in order to meet stricter new regulatory requirements
  • a desire to earn bigger profits on new loans to balance their losses on existing loans
  • the fact that banks have not been able to cut deposit rates as much as they would have liked, because they cannot cut the deposit rate below zero

Bigger banks

The Council of Mortgage Lenders (CML), which represents the UK's banks and building societies, welcomed the report, claiming that it showed there were valid reasons for the higher margins being charged.

"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," said the CML's chief economist, Bob Pannell.

The report also suggested that banks may be able to charge more because of a "reduction in the degree of competition within the banking sector following consolidation".

Earlier this month, the CML reported that mortgage lending had become much more concentrated in the hands of the biggest lenders since the financial crisis.

In 2009 the five biggest lenders were responsible for 82% of all mortgage lending, up from 62% in 2007.

This was partly because of some lenders dropping out of the UK market altogether, while others such as HBOS and Bradford & Bingley were taken over by rivals.

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