Recently there has been a lot of interest regarding the levels of lending, secured and unsecured, and its relation to the level of savings. The financial crisis created a great deal of uncertainty in the markets with banks significantly restricting the availability of credit while they reinforced the strength of their balance sheets. However, whilst the banking sector has been more willing to move towards business as usual, the impact on consumer behaviour has been considerable. Following the financial crisis and the global recession consumers have lived through widespread condemnation of excess borrowing. This has led them to realign their attitudes towards debt and they are less willing to take on what would have been considered reasonable financial commitments prior to the recession.
This effect is not limited to consumers. Anecdotal evidence suggests that business are also reluctant to take on additional debt, and currently markets are unsure how much of the current financial squeeze can be attributed to restricted financial products and conditions or to changing attitudes.
The above will have implications for monetary policy. For example Charlie Bean, who sits on the committee that determines the Bank rate, has reportedly said savers should ‘eat into’ the capital they have built up during low-rate times.
He told channel 4 news: “What we are trying to do by our policy is encourage more spending, ideally we would like to see that in the form of more business spending.” However, he also said “Part of the mechanism that might encourage that is having more household spending so in the short term we want to see households not saving more but spending more.”
Consumers and businesses are right to be wary of such comments given the financial hardship many have had to endure in the past few years. As with most economic decisions there are pros and cons of such action. Over the past few years the cost of lending has increased as the differential between the base rate and the rate charged on financial products has increased. This raises the cost of borrowing and so fewer consumers and business will undertake such actions. In addition to this the base rate being at historic lows is also eroding savers’ capital, as the inflation rate remains above that of the interest payable on most savings accounts. This would suggest that the most efficient use of savings would be to increase consumption or to reduce debt.
However, the increased level of volatility within the market has created uncertainty and so consumers and businesses will hold a greater degree of capital (at an economic cost) to account for eventualities and the degree of error that occurs because their expectations do not match that of the actual markets performance. Uncertainty over public sector cuts means this ‘safety net’ may be considerable in size.
How much has the lending market deteriorated?
Are the trends the same across consumer and business lending?
How do consumer and business lending interact?
Approvals secured on dwellings:
The latest data from the Bank of England shows the extent to which lending has been effected by the financial crisis and recession. The number of approvals of mortgages for house purchase for August stood at 47,372 and was slightly below that of July (48,346) and the previous six-month average (48,619). This does suggest that there is a degree of caution with regards to the financial commitments consumers are willing to take on, and that the tighter lending criteria and higher interest rates demanded by banks are restricting the ability of consumers to enter the housing market. Unlike other secured spending which has undergone a more gradual decline, re-mortgage lending significantly fell following the financial crisis from 117,382 approvals in January 2008 to 67,229 six months later in July before falling to approximately a quarter of the pre-crisis level a year later in January 2009 (34,252).
Figures on the value of lending secured on dwellings during the same period reveal a similar story with the total value of loans in August 2009 standing at £11.1bn. This compares to £33bn in November 2006 and is currently at levels last seen a decade earlier in 2000.
In early 2010 there was a slight improvement in the consumer credit market and the confidence of consumers to repay debt following the significant reductions that occurred as a result of the banking crisis. However, the upcoming spending review has once again raised consumers concerns with regards to the fragility of the economy. The potential for financial circumstances to deteriorate resulted in moves to pay off debts.
This could once again signal that attitudes towards unsecured credit are changing towards that of lower borrowing and higher saving. However, at its current level the base rate should disincentivise saving.
So, have consumers been able to save given the decline in wage rate growth, inflation, increased borrowing costs and low levels of interest and is this likely to continue to be their preference.
Whilst not directly related to business operations the ability for consumers to borrow allows them to consumer goods and services. If volatility is high and consumer confidence in the financial markets is low, they are less likely to spend. In contrast to this, they are also more likely to save and whilst saving reduces consumption it also improves the bank’s capital balances and provide them with money which they can lend to other consumers and businesses to drive investment.
If we look now specifically at business investment, data from the BOE shows the rate of contraction in the stock of loans has eased during 2010. Despite there still being indications that the financial environment remains challenging, there are signs of improvements within the markets.
The latest Credit Conditions Survey (2010 Q3) by the BOE concluded that:
“The amount of credit made available to the corporate sector overall had risen in the past three months. Within that, some lenders reported that there had been a larger increase for small businesses.”
“Lenders reported that demand from small businesses had fallen unexpectedly, but demand for loans from larger businesses had not changed.”
“Across all types of lending to both households and businesses, lenders reported that default rates had fallen in Q3 and losses given defaults were also generally lower.”
Overall lending conditions are slowly starting to improve, default rates have fallen and slowly products are returning to the market. What will be key over the coming 6-12 months is the degree to which the public sector cuts affect business and consumer income.
Whilst the environment is improving the cost of borrowing is still greater than business and consumers were used to prior to the recession, and so they are unlikely to take on credit given their recent experience of the recession and financial crisis. It is important that government, regulators and the financial sector take this into account when setting lending criteria. Whilst the financial crisis has provided some very harsh lessons that may entail more restrictive conditions on the level of borrowing that is available (in relation to a company’s or individual’s income) it is important that consumers and businesses are able to utilise financial facilities at a cost that reflects the risks and nature of the product.
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