Sunday, Feb 10, 2008
Why lowering interest does not rescue the banks
Me myself: Banks offering even higher interest rates
Even after the BOE has reduced interest rates twice the best saving account return has been around 6.9%.
And has not reduced even after .50 point cut in interest rates.
The reason is simple: The problem that these banks have is that they have a lot of loans on their books which is of poor quality and is getting poorer as time goes on. Hence they need money to put up for the losses.
ECB gave $502 BILLION dollars in liquidity (2 week loans) in Dec-Jan. This was taken up by not only european banks but also American banks via subsidary/partner banks. And now its time to pay back. The chances of ECB giving the same money back again is next to impossible.
So the sage continues and the banks need money even at higher rates from us as they will not lend to each other.
3 Comments
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1. deepak said...
One more thing I wanted to add
Nearly all of the sub prime loan in US and UK is variable rate (might have an initial fixed or discount period)
When BOE or FED reduces rates, this leads to reduction of interest payments by these sub prime mortgages.
So the banks who have these mortgages on their books can not sell them as the return on them has reduced and due to credit crunch the risk has reduced.
Hence lowering interest rates does not help but makes it difficult for the banks to sell them.
2. paul said...
"When BOE or FED reduces rates, this leads to reduction of interest payments by these sub prime mortgages. So the banks who have these mortgages on their books can not sell them as the return on them has reduced and due to credit crunch the risk has reduced."
Due to the credit crunch the risk has increased I think. The attractiveness of the fixed income loans decreased certainly. Banks also need cash right now rather badly, so the UK's subprime is being kicked where it hurts while savers are largely unscathed.
Good point.
3. Julianw said...
Remember, the reason why the banks want savers (retail depositers) is that this money is "real" money. Goes to help build reserve ratios they deperately need. Beter still if they can lock that money in for a year or so.
Note that the banks can borrow else where (Citi payed 14% recently to get their hands on some money); 7% to raise real money on the high street, probably looks like a bargain to them at the moment.
Of course there are some other, perhaps more desperate places the banks can go to get real money... extending settlement terms to retailers for credit cards for example.
Shrinking overdraft limits a few days after pay day, both for us and the companies we work for.
In other words, suck in a little of the cashflow in the world.
But these would be desperate moves.