Will the bail-out help your finances?
At the end of last year, the government announced a scheme - termed the banking bail-out - which it hoped would kick-start the economy by supporting banks during the downturn. It came at the same time as the Bank of England starting to cut interest rates in an attempt to reduce pressure on borrowers and businesses.
But despite these proactive measures, for most of us little has changed. Mortgage borrowers continue to struggle with payment shock, rates on new loans have not come down significantly and house price falls show little sign of slowing. At the same time, savers are suffering as headlines rates on fixed and instant access deals fall.
The economic outlook continues to look grim, with more job losses, businesses folding and a recession still very much on the horizon.
The government has now unveiled a second scheme to help support banks, increase lending and, hopefully, revive the flagging economy. But will the measures announced be enough to beat the downturn and get banks lending again? And what impact will it have on borrowers, savers, Northern Rock and Royal Bank of Scotland customers?
The second banking bail-out
The latest bailout include insuring banks against any losses they incur from “bad” debts. Banks will not have to pay for this insurance, but will have to declare losses they expect to make from particular debts. In return, the government will offer insurance against these losses up to 90%.
The logic behind this scheme is that such debt is hard to value, as banks are not currently able to sell it through the normal avenues, making it hard for them to know how much money they have on their balance sheets to lend. As a result, banks have been storing up their finances and restricted new lending.
The insurance scheme should encourage banks to increase their lending levels, as they have a government assurance of how much money they can expect to reclaim from the debts.
A second measure announced by the government is the launch of a guarantee scheme for asset-backed securities, a move recommended by Sir James Crosby in his investigation into how best to support bank lending to individuals and businesses.
This scheme aims to help banks access funding from the wholesale funding markets, thus supporting new lending, by offering Treasury guarantees to high quality asset-backed securities, including mortgages as well as corporate and consumer debt. The aim behind this move, which will not commence until April 2009, is to re-open the wholesale money markets thus enabling banks to increase their funding.
In additon, Northern Rock has agreed to ditch its plan to shrink its mortgage book by 60% and the government has upped its stake in RBS to 70%.
Impact on economy
The government hopes that the bailout will enable banks to start lending again to individuals as well as businesses.
In a statement, the Treasury says: “With the global economic downturn intensifying in the past two months, the government is announcing a comprehensive package designed to reinforce the stability of the financial system, to increase confidence and capacity to lend, and in turn to support the recovery of the economy.”
The move has been long awaited by the industry, with many commentators repeatedly calling for government help to restart the mortgage markets and support banks. Despite the Bank of England cutting interest rates from 5% in October to the historically low-rate of 1.5% in January, there has not been any significant evidence to suggest that this monetary policy is doing enough to boost lending and the economy.
However, despite the government ‘coming good’ and announcing these new measures, not everyone is convinced they are enough.
Vicky Redwood, UK economist at Capital Economics, says while it is a significant step, there are no magic solutions to the downturn.
“These measures will take time to get off the ground. Only the bare bones of the schemes have been laid out, some of which will not be put in place until April. More importantly, even with the government absorbing some of the losses on their most toxic assets, banks face huge amounts of recession-related losses in the next few years,” she warns.
Redwood also criticises the measures as failing to tackle “the heart of the problem”; namely, that banks do not want to lend during a recession. With losses still hanging over their heads, banks may be tempted to cling onto their capital and shore up their finances, rather than up their lending levels immediately.
“It is clear that the government has realised that the banking system will not start functioning properly again without more state intervention. Less clear is whether these measures, on their own, will be enough to kick-start lending.”
Impact on borrowers
The ultimate aim of the bail-out measures are to get banks lending again, which should be good news for borrowers looking to remortgage as well as first-time buyers. Once lending does return to 2007 levels, house price falls should slow, stabilise and eventually start to rise again.
But will the measures achieve these aims?
The Council of Mortgage Lenders, which has been calling for government initiatives to help banks cope with “bad” debts for more than a year, is hopeful. It believes the government guarantees should go some way to help to restart the securitisation market, allowing banks to sell mortgage and other debts to investors and raise funding for new lending.
But Michael Coogan, director general of the CML, warns: “As always, the devil will be in the detail and there will be a great deal to work through. No doubt, there may still be disproportionate impacts on some firms or some sectors from the latest measures, but overall this is a helpful package that we think is much more likely to help lending flow more effectively again than the steps that have been taken to date.”
Certainly, borrowers should not expect to see much difference overnight and a lot depends on how banks react to the measures.
David Breger, partner at HW Fisher chartered accountants, says: "The question, as ever, is will the banks pay attention to it, and if they do, how long before companies and consumers begin to benefit? Time is everything at the moment.”
And Redwood says: “It is clear that the government has realised that the banking system will not start functioning properly again without more state intervention. Less clear is whether these measures, on their own, will be enough to kick-start lending.”
She predicts that the government will need to go further over the coming months, potentially by nationalising more banks and setting lending targets for banks.
Impact on savers
Prior to the Bank of England implementing historical interest rate cuts, savers were largely benefiting from banks’ inability to sell debts on the wholesale markets. A need for funding encouraged savings providers to increase their rates and attract deposits.
Although savings rates have fallen dramatically since October, from highs of 7% to average rates around the 1% mark, experts said that a need for funding would continue to underpin some rates.
But, with the government measures designed to enable banks to start buying funding from the wholesale markets again, will this discourage firms from trying to draw in savers?
Michelle Slade, spokeswoman at data provider Moneyfacts, says there is now the potential for savings rates to come down.
“Interest rates on savings have been kept artificially high over the past year despite low Bank of England interest rates, because of funding restrictions for lenders,” she explains. “This potentially could now change but for smaller building societies and banks with a large number of savings customers, it shouldn’t make too much difference. These players won’t want to discourage their customers so they are unlikely to cut rates too much.”
As part of the banking bail-out, Northern Rock has agreed to slow down its mortgage redemption policy, which was first announced after the bank was nationalised early in 2008.
Northern Rock’s original plans was to reduce its mortgage book by 60%, partly by restricting new lending and also by encouraging mortgage customers being actively encouraged to move their loans to other lenders once their fixed introductory periods have expired. It did this by setting up a referral deal with Lloyds TSB and also by giving borrowers access to a panel of brokers to help them find a remortgage elsewhere.
Northern Rock says this policy has enabled it to pay off its government loan ahead of schedule. However, it now plans to slow redemptions and, therefore, repay the loan at a slower rate.
The impact on borrowers remains to be seen, although at this stage it does look positive for people with Northern Rock. The bank is carrying out a strategic review into how it can reduce the number of redemptions and more details are likely to be announced once this is concluded.
Jaqualyn Gill, a spokeswoman for Northern Rock, was unable to give a date when the review will be concluded but it is likely to be a question of weeks rather than months.
Until then, Gill says Northern Rock will “less actively” encourage borrowers to move away, although its existing deals with Lloyds TSB and its panel of brokers remain in place.
The bank’s current standard variable rate will change to 5.09% on 1 February, but Gill says this is under review and could potentially come down in a move to encourage borrowers to stay with the bank. In comparison, Cheltenham & Gloucester’s SVR is 3.5%, while Abbey’s is 4.94% and Halifax’s in 4.5%.
“We need to look at our SVR but once the review is concluded we will see more details emerge on how we plan to slow down redemptions,” she adds.
If the SVR is reduced, then this will be a big help for Northern Rock’s 100% mortgage borrowers, who are unlikely to be offered mortgages elsewhere.
As part of the banking scheme, the government’s stake in the Royal Bank of Scotland has increased from 58% to 70%. Although the Treasury has not invested any more money in the bank, it has converted its existing preference shares into ordinary shares. This means RBS will no longer have to pay interest on the government's stake.
In return, RBS is expected to increase its lending to homeowners and businesses by £6 billion over the next 12 months.
The changes shouldn’t have too much impact on the bank’s customers. On one hand, the fact that the Treasury now has a 70% stake in the firm should indicate that savers’ money is safe as the government is unlikely to let it ‘go to the wall’.
At the same time, one condition of the change is that RBS increases its lending. Melanie Bien, associate director at mortgage broker Savilles Private Finance, says that although it remains to be seen whether banks will increase their lending levels, RBS is committed to increasing lending by £6 billion this year.
This should mean lower rates on mortgages - and, potentially, loans for people without large deposits.
But the impending recession is still an issue. “Part of the problem is that the current climate of job losses and falling house prices should make banks more cautious about lending, especially to businesses,” Bien explains. “How they balance their own need to reduce risk with the government’s orders to increase lending remains to be seen.”
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.