British Lenders May Discontinue Many Categories of Loan Offerings on Fear of Default

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British Lenders May Discontinue Many Categories of Loan Offerings on Fear of Default

 British Lenders May Discontinue Many Categories of Loan Offerings on Fear of Default

Summary

  • Many of the British lenders expect households and businesses to default on their debts
  • The prices of mortgage contracts are expected to rise in the short term.
  • The banks witnessed an increase in credit offering to the corporate sector during the second quarter, underpinned by the support schemes launched by the Government

Banks are considered as the engines of the economy because they control the flow of credit in an economy, on which several businesses and sectors flourish. Banking is supposed to be one of the oldest sectors that have been carried forward into the modern world. During the unprecedented crisis, most of the banks and financial institutions were operational. They became an important cog in the wheel in facilitating the state backed schemes.

However, these schemes have exposed the lenders to increased risk of defaults and have placed them in a vulnerable state. The British lenders expect households and businesses to default on their debts. Now with the increased risk of defaults, loans are likely to get expensive and might even get discontinued across several categories, according to a recent survey done by the Bank of England (BoE).

Due to the economic impact of the novel coronavirus, banks expected the supply of credit to increase only slightly over the next few months, primarily driven by government-backed coronavirus credit programmes. However, the British lenders have piled on a lot of assets (loans) on their balance sheet, which is attached to higher risk weights.

According to the apex banking authority, banks are likely to reduce their exposure to mortgages and unsecured lending to households in the third quarter. In addition, the prices of mortgage contracts are expected to rise in the short term. All major lenders are expecting a surge in the volume and size of loan defaults across all categories of lending products, according to the quarterly survey conducted by the apex bank.

Let us understand a bank’s balance sheet or statement of financial position. On the asset side, the value of bank’s assets such as mortgages, business loans, credit cards are recorded. On the liability side, bank’s capital along with deposits from retail & corporate customers, are recorded. Now the bank relies heavily on these assets (loans) to generate revenue streams. If the asset quality depletes, the bank would eventually collapse into administration.

Emerging challenges in the Banking space

  • Emergence of P2P lenders

Fintech firms such as Zopa, have created a parallel banking industry with P2P (peer-to-peer) lending through their online platforms. Moreover, Zopa was recently awarded a full banking license recently. This would help Zopa to gain market share in the banking industry. Loans through P2P are more convenient and cater to a wider section of the society, which is often ignored by the traditional banks.

These fintech firms can eat away a significant amount of market share from the traditional banking system. These firms need far less documentation and provide convenient access to credit through lucid tech platforms. People can get loan amount disbursed in their checking account with just a few taps on their mobile devices with very less documentation. Technically, P2P lenders have the potential to turn the tables in the banking industry.

Also read: P2P Lenders Draw A Parallel Banking Industry Amid Covid-19 Crisis

  • The transition from LIBOR to SONIA

The London Interbank Offer Rate (LIBOR) has been in use for nearly four decades. LIBOR has been a key mechanism for pricing all the financial contracts such as derivatives or debt securities. Since its is decided secretly by a committee of bankers, there have been many instances in the past where the banks have manipulated LIBOR, and a few were also charged with hefty fines.

The central bank has directed the FCA and the other respective regulatory authorities to adhere to the deadline of March 2021 and switch to SONIA (Sterling Overnight Interbank Average Rate). SONIA is closely linked to the bank rate, which is controlled by the central bank of the country. Everything has a cost associated with it. This transition to SONIA would come at a cost which the banks must bear. In addition, this would certainly impact the revenue streams of the banks. Moreover, the banks might also have to undergo structural changes to redefine existing financial contracts which are due for expiry beyond 2021.

Also read: Central Bankers-Deadline for Phasing Out LIBOR Would Not be Extended

  • Increased exposure to assets, which could turn bad

During the unprecedented crisis, the businesses have been piling debts to stay afloat. Most of the debt is in the form of government backed schemes, which usually come with a mortgage holiday of 12 to 24 months. Given the prevalent uncertainties in the economy such as Brexit, plunge in oil prices, lesser interest rates, and global recession, things could go terribly wrong, and assets (loans) could turn bad.

On the supply side, British lenders were reluctant to offer secured credit offerings during the second quarter (three months to end-May 2020). A similar trend was observed in the unsecured credit offerings to UK households.

However, the banks witnessed an increase in credit offering to the corporate sector during the second quarter, underpinned by the support schemes launched by the Government to support businesses remain afloat during the unprecedented crisis.

On the demand side, secured lending such as housing loans has gone down in the second quarter. Due to the prevalent uncertainties with reference to Covid-19, people are trying to preserve cash and reduce their expenses. Rishi Sunak, the Chancellor of the Exchequer, recently announced stamp duty holidays for transaction up to £500,000. People might look to capitalise on this scheme and the lenders are likely to expect secured lending rise in the third quarter.

Also read: Bonanza for the Hospitality & Housebuilding Sector in Chancellor’s Summer Statement

UK Lenders such as RBS, Barclays and HSBC have recently seen their share price trading near a 52-week low. BoE has earlier predicted a contraction of nearly 30 per cent in the UK’s economy. Banks need to be prudent in their approach while offering loans and making the transition to new pricing mechanisms. The UK is in an uncharted territory of recession, where the debt has piled up in recent times. The world is desperately looking up at the global pharmaceutical industry to find a cure for the pandemic, which has the potential to trigger another financial crisis.

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