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Why mortgage rates won't fall

  • Robert Peston
  • 22 Apr 08, 05:20 PM

As credit has become more difficult to obtain and more expensive for most of us, two issues have become confused.

One is the shortage of cash in the coffers of some banks - which has been addressed to some extent by the to allow banks to swap their mortgages for the equivalent of cash.

But there is a second reason why banks haven't cut mortgage rates in line with recent falls in the Bank of England's official lending rate: in a slowing economy and with house prices dropping, banks believe the risks of lending have increased.

Banks are deliberately widening the difference between what they charge for money and what it costs them.

And in doing so they have the explicit support of the Governor of the Bank of England, .

Here are what the banks see as the killer facts that explain why consumers are wrong to moan about the cost of credit.

In 1998, the difference or spread between average mortgage rates and the Bank base rate was just under 1 陆 percentage points.

Last year that had narrowed to almost nothing, 0.27 percentage points, which meant that most mortgage loans were barely profitable.

Banks have since attempted to rebuild the profitability of mortgage lending and have doubled the difference between what they charge and the base rate.

They believe this is prudent, not extortionate. And some would argue that the insanity was when they lent too much too cheaply in the previous few years.

darling_bbc.jpgWhich is why the banks will resist the urgings for cheaper money coming from borrowers and the Chancellor. And it's also why the bonhomie between ministers and bankers that broke out at 11 Downing Street this afternoon will probably last about as long as it takes for them all to return to their offices.

RBS rebuilds

  • Robert Peston
  • 22 Apr 08, 07:19 AM

The City watchdog, the , is monitoring the health of banks much more assiduously than it was a year ago - and is assuring itself that each of them has enough capital to support their business plans.

royalbank_203ap.jpgThat's one of the reasons why has decided to raise a record-breaking 拢12bn of new cash from its shareholders in a rights issue.

Or to put it another way, the climate for banks has changed in a fundamental way.

It seems only yesterday it was all about growth and opportunities.

Today bankers have remembered - some would say belatedly - that there are risks associated with lending.

So Royal Bank has also announced that, on a permanent basis, it will retain more capital in its balance sheet to meet the risks of default by borrowers than it had been doing.

The bank's shareholders are not happy that it has had this awakening only after suffering record write-downs for a British bank (of 拢5.9bn before tax) on its investments and loans related to sub-prime and private equity (though they will, in the end, probably decide that the best punishment for the chief executive, Sir Fred Goodwin, is to insist he stay in place at least long enough to reap whatever incremental profits are available from the tricky job of integrating the sprawling international wholesale banking operations of the Dutch bank ABN, which Royal Bank acquired last year).

The scale of Royal Bank's humiliation is that it is raising an additional 拢4bn by selling businesses - including all or part of its substantial insurance operation - to cover those losses.

What about its big rivals? Are they too going to raise new equity capital through rights issues and disposals to reinforce their foundations?

None have quite the same urgent need as Royal Bank. But it would be slightly odd if Barclays and HBOS did not conclude that their advantage lies in pumping up their stock of capital earlier rather than later.

Why? Because in the new, scarier climate, the Financial Services Authority will allow them much greater latitude in pursuing their ambitions if they can swank that they are among the best capitalised banks in the world - and they can't boast that now.

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