Bank of England Governor Mervyn King stated recently that “the single most pressing challenge” to domestic economic policy is to revive bank lending.
The outlook for credit depends on funding pressures
Fears of a collapse in the financial system led a sharp deterioration in the economic outlook
Bank of England Governor Mervyn King stated recently that “the single most pressing challenge” to domestic economic policy is to revive bank lending. The restriction in the availability of credit for households and companies intensified sharply since the failure of Lehman Brothers in September. This event led to a near collapse in confidence in the financial system, resulting in a significant further downtrend in equities, a widening of credit spreads, a bursting of the commodity price bubble and sharply lower bond yields, as chart a shows. It was only after this event that the outlook for the economy took a significant turn for the worse. The government responded with measures including plans to recapitalise banks and to guarantee their refinancing of debt. The Bank of England also extended the amounts available in its Special Liquidity Scheme (SLS) and slashed interest rates to 2%, with further cuts expected in 2009.
Funding pressures have deepened
Thus, the funding pressures that existed for banks since the credit crisis began in August 2007 deepened following the collapse of Lehman. A key feature of the UK banking sector in recent years has been the increase in the customer lending gap, i.e. the difference between lending and deposits. This has risen to £740bn from a position of balance back in 2001, as asset prices and private sector debt levels soared – see charts b and c. This funding gap was
financed by debt securitisation and funds from the wholesale markets. However, since the start of the credit crisis, the volume of securitisations has dried up, as investors have been unwilling to fund purchases of asset-backed securities, as chart d shows. Moreover, funding from wholesale markets seized up and worsened further in September this year, see chart e. The flip side to soaring debt levels in the UK, and some other developed economies, is the large current
account surpluses and record foreign currency reserves in some emerging Asian economies and the Middle East.However, at least in the near term, such surpluses are unlikely to come to the rescue of the global financial system.