From savings to house prices, how the credit crisis affects you
As the run on Northern Rock continued yesterday, customers of other British banks were left to wonder if the credit crisis may affect their own savings providers.
Although several of the smaller banks – such as Alliance & Leicester and Bradford & Bingley – made reassuring noises, the reality is that they are the banks most likely to be hit next if the tough credit conditions prevail. Shares in the two organisations fell by 31 and 15 per cent respectively yesterday, as investors feared the worst.
But, given the Bank of England's commitment to support all solvent financial institutions, customers' money is completely safe. It only starts to be put at risk when thousands of customers begin to panic and demand their money back immediately.
The entire financial system works on trust. Banks carry out a careful balancing act, lending money with one hand, which they are taking from savers with the other. In the case of banks such as Northern Rock, Alliance & Leicester and Bradford & Bingley – who all lend more than they take in savings – they also need to borrow from the money markets to keep their businesses ticking over. The credit crunch has left some institutions unable to secure this additional borrowing – which is where the Bank of England has stepped in.
Customers of the largest banks have nothing to worry about at this stage. But publicly quoted companies, such as B&B and A&L, will be obliged to make a statement to the market if they are forced to fall back on Bank of England funds – and this may trigger a repeat of the Northern Rock crisis.
Remember that even in the very unlikely situation that one of the banks went bust, 100 per cent of its customers' savings are guaranteed up to £2,000; 90 per cent of the next £33,000 is also guaranteed.
After a week of fluctuating interest rates in the mortgage market, lenders held fire yesterday as they waited to get a clearer picture as to what may happen next.
Last week, several of the UK's largest lenders, including the likes of Halifax and Abbey, increased their tracker mortgage rates, as the cost of short-term lending increased.
At the same time, several other lenders reduced their fixed-term mortgage rates – reflecting a reduction in the cost of borrowing in the longer-term money markets.
Lenders finance their fixed-rate mortgages by borrowing in the swap markets. Swap rates have fallen over the past week, and fell sharply again yesterday, reflecting the fact that investors now expect the next movement in the Bank of England base rate to be downwards.
However, Libor – the rate at which banks lend to each other to finance their variable-rate loans – has soared as a result of the credit crunch. By the close of markets yesterday, Libor was still at more than 1 percentage point above the base rate, increasing pressure on lenders to raise their tracker deals, if they have not already done so.
With house prices already beginning to stall across the UK, a tightening in prime mortgage lending is likely further to dampen the housing market.
However, a full-blown crash remains unlikely unless levels of unemployment rise dramatically.
The impact on the UK stock market has been fairly muted. While Northern Rock has lost more than half of its value since the start of September, the FTSE 100 is down just over 200 points (just over 3 per cent) and remains higher than it was 12 months ago.
The UK market is relatively defensive and should be resilient enough to weather the storm. The FTSE 100 is dominated by a handful of massive companies, most of which should prosper regardless of the banking sector's woes. The oil, mining, pharmaceutical, tobacco and alcohol sectors have held up well and should continue to do so.
But anyone with any exposure to the stock market should be concerned, and that means anyone who has a pension, assurance or insurance. The potential domino effect of the collapse of a major UK lender could be catastrophic in the medium term, with confidence evaporating from a finance industry that has become bloated and overconfident.
Sympathy for City workers is likely to be in short supply should the next step be a massive round of redundancies, the odds on which are shortening by the minute. But financial services generate approximately 30 per cent of the UK's gross domestic product, and if City institutions stop spending the knock-on effects practically every other part of UK plc.
The days of securing easy credit look to be heading towards an abrupt end, with several credit card and personal loan providers likely to tighten their screening procedures and scrap their low interest offers over the coming weeks.
Although many of the cheapest personal loans currently charge interest of just 6.3 per cent – only 0.55 percentage points above the Bank of England base rate – such competitive rates are likely to be increased over the coming weeks.
For those with poor credit ratings, it is likely to be very difficult to secure borrowing facilities – even at high interest rates.
There will be some dent to the economy. At the moment, the economy is still growing strongly at close to a 3 per cent annual rate. That is above its long-term average and was going to come down anyway as growth in consumption was curbed by higher interest rates. But the world economy has been growing fast, exports have been strong, investment is good and the UK remains pretty competitive. Growth was going to slow anyway, and if this were to happen too sharply that would reduce inflationary pressures and interest rates could come down. Growth of, say, 2 per cent next year might seem a bit disappointing, but actually would be perfectly all right.
But this does assume that order is restored quickly, which the Chancellor's unprecedented statement may have done. If it hasn't, and if the run were to extend to other banks, then there is a danger that the supply of mortgages would dry up and that the housing market would be very exposed. If there were a double-digit fall in house prices over the next year, then consumption would stagnate and a recession could not be completely ruled out.