Bail-out could create two-tier banking sector

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Is the banking sector splitting in two?

After last week’s surprise 1.5 percentage point Bank of England rate cut, the three big banks that have received equity injections from the government all appeared to bow to government pressure. In the wake of meetings with Alistair Darling, the chancellor, Lloyds TSB, Royal Bank of Scotland and HBOS all cut the standard variable rates on their mortgages by the same amount.

In stark contrast, HSBC and Barclays, which have declined government help, did not cut their SVRs.

The obvious conclusion is that here is early evidence that government pressure is being exerted to create a two-tier banking system – one that is consumer-friendly, though perhaps at the expense of shareholders; and the other that is more traditionally commercial, and perhaps a better shareholder bet as a result.

So far, at least, investors and analysts seem not to buy the theory.

It is premature to read too much into the banks’ mortgage rate strategies, says Graham Ashby, head of UK retail equities at Credit Suisse. “The interest rate cut was very recent and it’s too early to tell exactly how it will feed through. Too much is being read into SVR changes.”

Most borrowers are on variable and fixed rate mortgages, rather than SVRs, so the commercial impact of lowering SVRs is minimal for the likes of Lloyds, HBOS and RBS.

Conversely, HSBC and Woolwich, the lending arm of Barclays, although they have not cut their SVRs yet, have not ruled out a reduction, saying the situation was under review. Neither bank has a large share of the mortgage market, but both offer competitive fixed and tracker rates.

Brokers also point out that SVR changes have not been restricted to Lloyds TSB, Royal Bank of Scotland and HBOS. Other banks that have been absent from the government bail-out, such as Santander-owned Abbey, also cut their SVRs.

Alex Potter, analyst at Collins Stewart, says it is too early to draw conclusions beyond the statements that both banks and the government had made about the limits of state intervention.

Matters are expected to become clearer when banks unveil new variable mortgage rates this week. Following the latest interest rate cut, lenders withdrew from sale almost all tracker mortgages, which follow base rate movements.

With the Libor rate – the basis for banks’ borrowing costs in wholesale markets – now so much higher than the Bank base rate, experts believe there is a possibility that tracker mortgages could be revived in a different form – pegged to Libor rather than the base rate.

Amid the furore about lenders often not passing on base rate cuts to customers, banks have been at pains to point out that though the base rate is 3 per cent, Libor is closer to 4.5 per cent.

This 150 basis point gap far exceeds historical patterns, which show a difference of more like 16bp. Banks argue the new order of world financial markets suggests the current disparity is likely to continue.

In other words, interest rates are likely to stay low for some time to come, while wholesale money is likely to remain expensive.

If they do start to price loans more usually from Libor rates rather than the base rate, this could push up the cost of mortgages.

Already some lenders, including Paragon, the buy-to-let lender, price some of their mortgages from Libor.

Ray Boulger, technical director at Charcol, the mortgage broker, believes more mortgages might be priced in future from Libor, but he is not convinced it will become mainstream.

“The key issue is that many consumers would not understand Libor rates and the banks would have to spend time explaining it to them and dealing with customer complaints,” he said.

Only about 10-15 per cent of UK mortgages are on standard variable rates where banks can pass on Bank of England rate cuts. About 50 per cent of mortgages are fixed rate and
35 per cent track Bank rates.

There is a general feeling that banks – even the government-backed ones – will be cautious about passing on the next base rate cut. But if that view proves wrong, and the likes of RBS, Lloyds and HBOS keep cutting when others do not, there is a risk that commercial investors start discriminating against the banks that have accepted government money.

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