The Bank of England's blindspots

Peter Warburton - 02 August 2017

Under Mark Carney’s leadership, the Bank of England has maintained a much higher media profile. These days, the Bank blasts us with messages about the merits of plastic banknotes, its planned US-style town hall meetings and what it is doing to keep us all safe.  The Bank wants to be loved. However, while eager to express a prominent media message on consumer indebtedness, Bank officials are mute on the post-Brexit surge in UK bank lending to financial institutions.

Members of the Bank’s Financial Policy Committee – notably Andrew Bailey and Alex Brazier - have been out in force recently to hammer home a cautionary message on household borrowing. Despite paltry annual growth rates of total mortgage lending (3.8% for June) and deceleration in previously concerning growth rates for non-mortgage lending (7 per cent, down from 10 per cent), the FPC is on the warpath.  The Bank sees “some tentative signs of boundaries being pushed” and that “mortgage lending at higher loan to income multiples has edged up.” The pitfalls – for car finance companies – of the promotion of Personal Contract Purchase (PCP) plans are worthy of serious consideration.

All well and good that the FPC should be crawling all over developments in household borrowing and marginal forms of consumer credit.  However, by far the most troubling increase in lending by UK monetary financial institutions over the past 12 months is to other financial corporations (OFCs).  A consistent data set for the detailed decomposition of lending to OFCs is available only from 2011, obstructing the obvious comparison with the lead-in to the global financial crisis of 2007-09. However, what we glean from the data (figure 1) is that lending to OFCs bottomed in early 2016, since when the rebound has been aggressive.

The focus of attention is the fund management sector, including pension funds, and the central clearing counterparties (CCCPs).  Who are the asset managers that employ significant leverage? Private equity funds spring readily to mind.  Vulture funds, for want of a better expression, await the next economic downturn and equity market correction that will present the opportunity of carrion. CCCPs clear a very significant proportion of the European repo market. During the 2007 crisis, CCCP clearing helped to preserve access to the repo market for some peripheral Eurozone countries that were being squeezed out of the uncleared market as other banks cut their risk limits. Is there an echo in the recent expansion of CCCP borrowing?

Regardless of the detailed narratives underlying this surge in financial borrowing, there is a general point to make: that the extension of the regime of very low interest rates has incentivised a new wave of potentially dangerous leveraged expansion of financial activities. The failure to prioritise interest rate normalisation leaves the Bank wide open to criticism that it has fostered a boom in financial engineering. If financial asset prices suffer a material correction, the losses on financial loans could swamp those on household lending.   

Figure 1

Source: Bank of England Bankstats

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