There is no getting away from the fact that the UK economy is struggling. There are serious concerns about the short to medium term outlook for Brexit and uncertainty in the business sector. Against this background it is difficult to see UK base rates moving higher any time soon. Therefore, as a consequence we are likely to see relatively low mortgage rates for some time to come. However, there is another reason why there is intense competition across the UK mortgage market.
Changing regulations
In light of the 2008/9 US mortgage crisis, which led to one of the most damaging economic crises of recent times, governments and central banks around the world were forced to tighten banking regulations. In essence there are two types of banking operations, investment banking and traditional banking which includes deposits, loans and mortgages. Many of the larger high street banks have both a traditional banking arm and an investment banking business as part of one group.
When you hear about huge bonuses for bankers it is more likely they are involved in the investment banking industry. While profits can be volatile, when the market is good the market is very good and some of the profits banked are obscene. However, as markets turn, so can the prospects for investment banking and we have seen some huge losses over the years. Indeed, the US mortgage crisis was brought about by so-called “casino banking” where mortgage companies were working on the thinner and thinner margins until the market finally collapsed.
You will find that traditional banking deposits were used to partially fund the investment banking operations of many large banks. However, recent regulatory changes have stopped this!
Ring fencing investment/traditional banking funds
Regulations brought in by the Bank of England have effectively separated the internal businesses of traditional high street banks. Investment banking operations are run totally separately and there is no cross funding from the sedate traditional banking operations. When you bear in mind that current interest rates on savings accounts are minimal, this would have been the perfect scenario for investment bankers. Cheap funding from the traditional banking side!
As a consequence of the new regulations, many banks in the UK are awash with liquidity which they cannot transfer to the investment banking division. They therefore need to pump this into mortgages and personal loans. When you bear in mind the minimal, if any, savings interest rates on offer by high street banks these are in effect free loans. So, it is no surprise to see that many traditional mortgage lenders have been slashing their interest rates and offering mortgage deals which “appear too good to be true”.
Mortgage banks need to ramp up their return on deposit funding. As they are not able to transfer these funds to their investment banking divisions, it has in many cases become a race to the bottom in the mortgage sector.
Benign UK property market
The fact that many property investors in the UK are waiting to see the outcome of Brexit (in light of the forthcoming general election) has created a benign environment for the UK property market. So, traditional mortgage lenders are now being forced to slash their mortgage rates to tempt property buyers into the market. We’ve also seen a significant increase in remortgage transactions which again offer healthy returns for traditional banks using client deposits as funding. So, with UK base rates unlikely to move higher in the short term, uncertainty regarding Brexit and banks awash with funding, this is the perfect environment for relatively low mortgage rates for the foreseeable future. However, things can change very quickly, as they say, 24 hours in politics is a long time!