Beware the credit crunch, says Bank of England

25 October 2007
The biennial Financial Stability Report released by the Bank of England today warns that the ‘credit crunch’ crisis is still taking its toll in the UK. It indicates that those most at risk are companies and individuals that are dependent on borrowed money. However, others that could feel the pinch include shareholders, first-time buyers and buy-to-let landlords.

In the aftermath of the Northern Rock debacle, the Bank has set down a number of lessons that need to be learned if the economy is to keep its head above water and describes the knock-on effects of the US sub-prime crisis as “the most severe challenge to UK financial system for several decades”

It suggests that, in the current climate, banks need to improve their liquidity management and that consumers need to feel savings are protected if they are to keep faith with banks. It cites “over-reliance on continuous liquidity in financial markets” and “inadequate liquidity risk management” as contributing factors to the predicament, and as pitfalls to avoid in the future.

The report also points out that house prices are no longer rising at such a swift pace and that a number of lenders have introduced tougher measures for those wishing to buy or rent property.

“Recent investors are relying on continued house price appreciation to earn positive returns,” it says, adding that “buy-to-let investors have often invested in new-build flats in the United Kingdom, which have experienced much lower rates of price appreciation than houses.”

And those who might feel their money is safe despite the current climate could also be inadvertently affected. Many will have invested in shares, either directly or through pension schemes; and the value of these could fall if share prices take a tumble as a result of recent events.

Although the Bank of England has not overtly admitted failure in its handling of the Northern Rock situation, the report says that it “will consider carefully the design of its lending facilities in times of stress to maximise the chances of these being effective”. It adds that it will monitor individual banks more closely in the future as well as improving communication with the public.

It warns that: “The financial system is more than usually vulnerable to further adverse shocks – sourced either in recent events or from new sources, such as the equity markets or a weakening commercial property market.”

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