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Banks warned over lending fears Bank says credit fears overstated
(about 1 hour later)
The Bank of England has warned that banks' fears of a financial meltdown may become a self-fulfilling prophecy. The Bank of England has said that banks' fears of losses from the credit crunch may be exaggerated.
Banks previously over-willing to lend are now too reluctant, even with credit-worthy borrowers, it suggests. And it warned in a Financial Stability Report that fears of financial meltdown may become a self-fulfilling prophecy.
This increased fear of risk has itself undermined confidence in financial institutions and made them reluctant to lend to each other, the Bank adds. Banks previously over-willing to lend are now too reluctant, even with credit-worthy borrowers, it suggested.
This increased fear of risk has itself undermined confidence in financial institutions and made them reluctant to lend to each other, the Bank added.
The Bank of England thinks their fears are exaggerated Robert Peston, BBC business editor Read Robert's thoughts in full
The bank said that credit markets "are likely to overstate significantly the losses that will ultimately be felt by the financial system and the economy as a whole".
BBC business editor Robert Peston said the report marked a substantial shift in emphasis for the Bank of England.
"Financial institutions are currently assuming that losses on sub-prime will be on a scale without any precedent," he says.
"The Bank of England thinks their fears are exaggerated."
"It now believes that the market price of sub-prime investment products overstates likely future losses on sub prime lending by about 100%."
Losses
Its financial stability report suggests the credit exposure not written down by UK banks may be near to £100bn.Its financial stability report suggests the credit exposure not written down by UK banks may be near to £100bn.
The twice-yearly report says that there is a "significant increase" in the risk that a major bank collapse or reluctance to lend will disrupt the financial system.The twice-yearly report says that there is a "significant increase" in the risk that a major bank collapse or reluctance to lend will disrupt the financial system.
And it says the process of adjustment is proving "even more prolonged and difficult" than expected.And it says the process of adjustment is proving "even more prolonged and difficult" than expected.
The Bank still judges that the most likely outcome is that confidence will gradually return to markets, and does not see that all the exposure will result in losses.The Bank still judges that the most likely outcome is that confidence will gradually return to markets, and does not see that all the exposure will result in losses.
But the size of the problem helps explain why the Bank was prepared to provide an additional £50bn to help ease the credit crunch facing UK banks.But the size of the problem helps explain why the Bank was prepared to provide an additional £50bn to help ease the credit crunch facing UK banks.
In its Financial Stability Report, the Bank of England warns that there are potentially large exposures that have still not been declared by financial institutions. The Bank of England also warns that there are potentially large exposures that have still not been declared by financial institutions.
It says the credit crisis demonstrated that banks' risk management systems were weak, and they had not realised that risks could not be easily dispersed around the financial system but would flow back to the banks themselves. It added that the credit crisis demonstrated that banks' risk management systems were weak, and they had not realised that risks could not be easily dispersed around the financial system but would flow back to the banks themselves.
The Bank of England judges that there is a risk that "the currently elevated risk premia in some markets will persist".The Bank of England judges that there is a risk that "the currently elevated risk premia in some markets will persist".
"This could lead to a self-fulfilling adverse cycle in which persistent market illiquidity and falling asset prices further undermine confidence in banks and results in a sharper tightening of credit conditions." "This could lead to a self-fulfilling adverse cycle in which persistent market illiquidity and falling asset prices further undermine confidence in banks and results in a sharper tightening of credit conditions," it said.
Lending drying upLending drying up
The report demonstrates how quickly lending is drying up.The report demonstrates how quickly lending is drying up.
The Bank's quarterly survey of credit conditions shows that lenders are tightening up credit sharply not just on home loans, but also on household lending and commercial loans to companies.The Bank's quarterly survey of credit conditions shows that lenders are tightening up credit sharply not just on home loans, but also on household lending and commercial loans to companies.
And the sources of future loans in wholesale money markets have also contracted sharply.And the sources of future loans in wholesale money markets have also contracted sharply.
The market for "asset-backed securities" such as sub-prime and other mortgages has collapsed - with the value of such assets issued going from $700bn a quarter in the middle of 2007 to just $100bn in the first quarter of 2008.The market for "asset-backed securities" such as sub-prime and other mortgages has collapsed - with the value of such assets issued going from $700bn a quarter in the middle of 2007 to just $100bn in the first quarter of 2008.
What can be done
The Bank of England argues that to rebuild financial confidence, it will continue to allow UK banks to swap illiquid assets with safe UK government securities.The Bank of England argues that to rebuild financial confidence, it will continue to allow UK banks to swap illiquid assets with safe UK government securities.
And they say that banks will need to bolster their capital and make further disclosures of their financial position, and explain better how they are valuing complex financial instruments.And they say that banks will need to bolster their capital and make further disclosures of their financial position, and explain better how they are valuing complex financial instruments.
In the long term, the Bank of England wants to change the rules under which banks operate, so that they recognise risks, and possibly put aside some extra money in good times to secure against risk in bad times.In the long term, the Bank of England wants to change the rules under which banks operate, so that they recognise risks, and possibly put aside some extra money in good times to secure against risk in bad times.
And it says that more effective systems are needed so that central banks can respond more quickly in a crisis, such as the run on the Northern Rock.And it says that more effective systems are needed so that central banks can respond more quickly in a crisis, such as the run on the Northern Rock.