Richard Murphy, Bank Rate and bank margins

Here Richard Murphy points out that a rise in Bank Rate would lead to a rise in margins.  This is a fair argument.

Indeed, the main reason why MPC decided not to cut rates closer to the zero floor in March 2009, a view it held to until February this year, was that further cuts would eat into bank profits.  This was undesirable because it would either destabilise some institutions, or simply cause them to raise rates on some of their products.  The reason for this view was that banks had sold tracker rate mortgages which fell as Bank Rate fell, yet interest rates on deposits were, naturally, bounded at zero.  In theory banks could have charged for deposits in other ways, but that was likely to be politically awkward.  Some falling mortgage rates and constant deposit rates meant lower margins.

My view was that it was not a good idea to mix interest rate policy – which works not simply through banks – with what at that point was a retail bank financial stability policy.  Rates should have been cut lower, and offsetting policies, where they were justified on systemic grounds, contemplated.  [In truth, it wasn’t really ‘my’ view, but one formed by talking to a couple of other clever people at the time who can’t be named].

But, likewise, just as I thought rates should have set this consideration aside on the way down, I don’t think interest rate rises should be delayed on the grounds that they may cause this mechanism to go in reverse.  There many reasons not to raise rates now, but this isn’t one of them.

In fact, one might see this simply as the unwinding of a distortion on bank balance sheets cause by the need for super low interest rates for macroeconomic reasons.

There is a broader question about why banks expose themselves in this way.  Presumably, it was simply because, like the rest of us [and the Treasury included, who set the 2 per cent inflation target] no-one forecast zero Bank Rate would ever be necessary.  The hope would be that either banks learn their lesson;  or some action [like raising the inflation target at some point] was taken to lower the chance of a zero bound episode.  Or some regulatory intervention to prevent exposure to zero rates is considered.  Or, perhaps all three.

There’s also an issue for competition policy, of course, in figuring out whether margins averaged over the cycle are bloated.  But, once again, that’s not something to address with the instrument we use to achieve the inflation target.

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10 Responses to Richard Murphy, Bank Rate and bank margins

  1. mrkemail2 says:

    “The hope would be that either banks learn their lesson; or some action [like raising the inflation target at some point] was taken to lower the chance of a zero bound episode. Or some regulatory intervention to prevent exposure to zero rates is considered. Or, perhaps all three.

    There’s also an issue for competition policy, of course, in figuring out whether margins averaged over the cycle are bloated. But, once again, that’s not something to address with the instrument we use to achieve the inflation target.”
    There are actually good arguments for remaining at the “zero bound.” Warren Mosler and Milton Friedman recommend it.
    See this reform proposal. It also addresses competition. Any thoughts Tony?:
    http://www.3spoken.co.uk/2013/05/making-banks-work.html?m=1
    One point is as returns are decreasing you need low rates to fund projects.
    Far better to deal with excess bank lending by seeing what banks lend *for* than raise rates.
    As to “the instrument we use to achieve the inflation target” why not use other better instruments for example fiscal policy, than can be targeted.
    Raising and cutting rates has mixed and uncertain effects.
    Whereas fiscal policy and commodities price falls are far more important.

  2. mrkemail2 says:

    To paraphrase Cullen Roche:
    “the “logic” appears to amount to “we’ve been at 0% for too long”, “the govt wants to raise rates so they can lower them later”, “we need to fend off financial instability” or “we just need to get that first hike out of the way”. These arguments display a total lack of risk/reward analysis.

    First, the “natural” overnight rate is 0% because a banking system with excess reserves will bid the overnight rate down to 0% naturally. People who argue that overnight rates have been “mispriced” or “manipulated” flat out don’t understand how reserve banking works. Second, raising rates 25 bps does not provide ammo for later on. If massive rate cuts didn’t spark a recovery then why would cutting from 25 bps? “

  3. Costas Milas says:

    Hi Tony,
    This is indeed a fascinating issue to debate. Back in 2013, Chris Martin and I published here
    (http://www.sciencedirect.com/science/article/pii/S1572308912000563) a paper which finds that when IMF’s financial stress index (this is a composite of the TED, term and corporate debt spreads, returns and volatility in equity markets and exchange rate volatility; see http://www.imf.org/external/pubs/ft/wp/2009/wp09133.pdf) rises “much”, UK policy-makers respond to that.
    My personal view is that since, as we speak, the stress index is probably not (too) high, UK policy-makers should continue with a typical Taylor rule. Again, my view is that this policy rule now points to a policy rate of somewhere between 0.50% and 0.70%.
    Thanks,
    Costas
    PS Sorry for promoting the M&M paper.

  4. eric says:

    As an old, retired chief credit officer, I can tell you that low i-rates not only mean narrow NIMs,
    but also, symptomatic of a weak economy, higher probability of default and LIED, especially
    in SMEs. This makes banks very cautious about lending!

  5. Peter Whipp says:

    If I am wrong, please correct me. I note that bank deposit rates are very close to zero and mortgage rates about 4%pa. Cannot banks charge their debtors as much as the market will allow and can they not pay their creditors as little as the market will allow. Pleas will you explain just what influence the Bank of England now has on these market rates.

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