Opinion | Tuesday, 31 October 2007

Will the global credit crunch hit us ?

It is surprising and yet reassuring how the credit crunch which hit global banks because of sub-prime mortgage crisis has so far spared us. Read the Economist magazine and you will notice how the credit crunch has reached a new intensity, with the cost of borrowing money in London’s money markets hitting a new high in spite of the Bank of England’s attempts to cool the system by pledging to inject more cash. UK manufacturers have become more pessimistic about the business environment in the wake of the credit crunch, the latest quarterly CBI Industrial Trends survey has revealed. There are mixed messages. This survey shows that despite the drop in credit sentiment, orders grew strongly and there is little evidence so far of negative impacts of the recent global financial instability.
A balance of 13 per cent of firms are less optimistic about the business situation than they were three months ago.
Manufacturing output increased at its slowest rate since last October, with a balance of 1% reporting growth, although a balance of 10% predicts growth in the three months ahead. Based on the survey, the CBI estimates 7,000 jobs were lost in the sector in the third quarter of 2007, and that 10,000 will be lost over Q4. All this coincided with news of the first collapse by a British sub-prime mortgage company as a result of the market meltdown. Victoria Mortgage Funding, a small lender, has been placed in administration after funding lines dried up. High street banks are preparing to write off an unprecedented £6.6 billion as Britons default on a record amount of personal loans and credit card debt. Lloyds TSB yesterday revealed that its personal customers in Britain defaulted on £1.24 billion in 2006, including £740 million of personal loans and £490 million of credit-card debt.
It is not so difficult to blame the after effects of relaxed bankruptcy rules and the aggressive marketing of Individual Voluntary Arrangements ( IVA ) which have encouraged more borrowers to walk away from their debts. To explain better the use of IVAs has paved the way for many pacts to be signed between lender and borrower facilitating the recovery of debts.
This works by allowing a portion of the debt to be written off and the rest repaid under a five-year agreement. It is regretted that of late personal insolvency levels in Britain rocketed to a record 107,000 cases last year. The Financial Services Authority said last month that Britain’s huge personal debt levels now exceed more than £1.3 trillion including mortgages .It goes without saying that on its own this mountain of slow moving debt is one of the biggest risks to financial stability. Commentators have pointed out that combined with a slight rise in unemployment or interest rates this may lead many households into real difficulty. Estimates show that in Britain up to 2 million households are estimated to be “permanently indebted” — able to meet minimum interest payments but with no real prospect of ever paying off their debts. Total unsecured borrowing by households in United Kingdom has doubled to £212 billion in the past nine years. In London , we also witnessed pictures of long queues of pensioners waiting to clear their savings out of the Northern Bank . This was the result of a run on the bank following rumours of the credit crunch. So what actually happened and why did the cost of borrowing intra banks rise so suddenly?
It all started with the unexpected increase in the London Interbank Offered Rate (Libor), the key measure of how much money costs on the City’s open market.
The recent increase was taken as a sign by economists that markets are still worried about the Bank of England’s decision not to inject sufficient liquidity into the system, in the form of cheap borrowing. Fortunately the US authorities took early remedies as did its counterparts in the eurozone to make cheaper credit available to banks.
With the inter-bank lending market seized up, banks fear they may have to finance the debts with their own reserves, causing immense strain on their balance sheets.
Quoting John Wraith of Royal Bank of Scotland he warned of potential knock-on effects for the wider economy, as businesses and consumers start to face higher borrowing rates. In his own words “it does starkly illustrate that a very material degree of monetary tightening has occurred through risk aversion in the money markets, without any direct change in the official monetary policy rate,”.
The president of the European Central Bank, Jean-Claude Trichet, said the situation “calls for close observation and monitoring”, even if the world economy remains strong.
Recently,Ben Bernanke, the Chairman of the US Federal Reserve, said that the housing market slump in the United States would remain a significant drag on American economic growth for many more months and that although credit market conditions had eased, significant risks remained.
Mr Bernanke added that conditions in financial markets have improved slightly since the worst of the problems in mid-August. However, a full recovery is likely to take time and setbacks are inevitable. Rising interest rates, combined with falling home prices, have caused many sub-prime borrowers in U.S to default. More than 30 sub-prime lenders have declared bankruptcy or put themselves up for sale. Red flags about the sub-prime-mortgage market started to wave back in early February, when Europe’s biggest bank, HSBC, told analysts that its charge for bad loans would be more than $10.5 billion for 2006 — 20% more than analysts had expected.
So can we say that banks are using their old trick of lending you an umbrella in sunny weather only to demand it back in anticipation of a storm. Not really says Eric Daniels, Lloyds’ chief executive. When asked about the state of play he brushed aside concerns about the mushrooming debts, saying that the money written off was just 1.18 per cent of average lending.
According to him Lloyds ‘s policy is not to lend money to people who can’t repay it. As can be expected he declined to accept that the banking industry had been responsible for reckless lending, though every bank has tightened up its unsecured lending criteria in the past two years.
So coming close to home are our banks facing any problems with a deluge of struggling borrowers. Is there an army of borrowers out there who could previously find a fresh source of credit to tide them over but are suddenly finding credit cut off as banks tighten their lending criteria. Prima facie ,it does not seen this way at all although there is some tightening to the construction industry.
Starting with Bank of Valletta Plc only last week its Board of Directors approved the final audited financial statements for the financial year ended 30th September 2007. There are no worries about recalcitrant borrowers. In fact it boasts a record profit of Lm43.7 million before taxation for the year under review, compared to Lm38.4 million in 2006, representing an increase of 13.9%. Analysts reveal how the locally managed bank has achieved a marvelous turnaround even though the economy has only increased in GDP growth by 0.6% over last year. BOV has beaten the laws of gravity when it registered an improved return on equity for the year of 26.4% . (2006: 25.2%). Equally bullish was HSBC Bank Malta p.l.c..
During its first half 2007 results it prides itself on a generous profit before tax of Lm25.3 million (EUR58.9 million) for the six months ended 30 June 2007 - up Lm4.7 million (EUR10.9 million), or 23.1 per cent, compared with Lm20.6 million (EUR48.0 million) for the same period in 2006. To conclude there is no apprehension that the major banks in Malta have felt the chill permeating from the global credit crunch. If anything it appears that they have broken through the glass ceiling reporting bumper profits. Whether this is sustainable next year when commissions on euro conversions will drop and the overheated real estate sector will come home to roost is anybody’s guess.

George M. Mangion
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