London: The possibility of negative interest rates is adding to the cocktail of headwinds facing UK lenders.
Britain’s consumer-facing banks including Lloyds Banking Group Plc, Natwest Group Plc and Barclays Plc face seeing their earnings from mortgages and other loan products dwindle even further after policy makers at the Bank of England gave their strongest signal yet that they’re considering using subzero interest rates. Shares in the lenders fell Friday, adding to steep declines this year.
The firms are already being hit by a pandemic at the same time as their home market is negotiating its exit from the European Union, its biggest trading partner. There’s also the risk of a jump in unemployment that could hit loan repayments and push up defaults.
“Its a big risk for the banks in terms of lower revenues,” Colin Jackson, an analyst at Goodbody, said “The outlook for revenue is already bleak under lower for longer rates exacerbated by Covid.”
Drag on interest margins
A foray into negative rates in the U.K. would drag net interest margins lower still at lenders and further squeeze the supply of the riskiest mortgages, said Bloomberg Intelligence’s Jonathan Tyce. That would dent house prices and consumer confidence, he added.
The banks didn’t respond to requests for comment.
Europe’s half a decade experiment with negative interest rates has put pressure on lending revenue and burdened banks with billions of euros in penalties for parking cash with the central bank. There are concerns that the traditional dynamics of borrowing and lending are being distorted, with some wealth managers charging for deposits.
“In the long run, negative rates ruin the financial system,” Deutsche Bank AG Chief Executive Officer Christian Sewing said in 2019.
But with the threat of negative rates looming, banks are bracing themselves.
Sterling Libor - the rate that banks can theoretically borrow from each other - is near record lows across most tenors. But there are signs that financial institutions are worried about exposure and pricing themselves out of some lending.
Fixed mortgage rates on the riskiest loans jumped in August by the most in at least seven years, according to Bank of England data compiled by Bloomberg. It’s probably driven by banks wanting to reduce or slow the growth of their lending books to improve their capital ratios and offset the cost of risk or default in other parts of their loan book, said Antoine Bouvet, a senior rates strategist at ING Groep NV.
The result is that the gap between the loan rates and the yield on two-year government bonds is the widest since 2017, suggesting that the ultra-low borrowing costs among financial companies isn’t being filtered into the economy.
“Negative rates haven’t generated much inflation in the eurozone so as a policy tool there are questions marks over its effectiveness,” said Goodbody’s Jackson. “It does do a lot of harm to banks and weakens confidence so you need to be sure that you get an economic benefit from it.”