Bank Base Rate Cut can it help or hinder the public.,

The credit crunch is undeniably having a huge impact on peoples finances, and with credit being harder and harder to obtain, the general focus is now on interest rates and how they will affect the individual. LIBOR, once only heard of in financial circles, is now the hot topic of conversation across the nation, as media coverage speculates on the possible outcomes of financial aid packages.
As a nation, we are now all aware that LIBOR, or the London Inter Bank Offered Rate, is the rate at which banks borrow from one another, and is therefore a benchmark for how the lending markets worldwide should react.
The rate is calculated by the British Banking Association (BBA) which takes the lending rate from 16 different contributing panels. They then disregard the top and bottom 4, concentrating on the middle average 8 rates. The average of these becomes that day's LIBOR rate.
Over the last twelve months the difference between the LIBOR rate and the Bank of England base rate has been substantial and it has also been acknowledged that the period of this variation is also longer than ever before. There has recently been a drop in the rate with a 1.065 percentage reduction on Friday 7th November giving a rate of 4.496% (its lowest point since April 2004), reflecting a slashing of the interest rate by 1.5% to 3% by the Bank of England. The pressure has been put on the financial institutions to pass this on to the general public, not only by the government, but also by the media. With this in mind, many of the leading banks are following the Bank of England's lead.
But there would appear to be several things that have been overlooked in the rush to pass on the perceived benefits of the drop in the base rate.
Current customers will of course welcome a reduction in interest rates. For the bank, however, this can have a damaging effect on arrears performance. As borrowers are set to pay less monthly, this automatically puts up arrears percentages. For example, if a borrower normally pays 350 a month, but is 300 behind, they are effectively not an issue as yet. However, if those monthly payments are brought down to 290, that 300 in arrears is considered to be over a month's worth of payment, which then puts them on the problem list. This will have a knock-on throughout, as people who are 1month behind move to 2, 2 to 3 and so on. Therefore, the amount of people being litigated against will also increase.
You then have to take into account the effect it has on one banks willingness to lend to another bank. Due to the rate cuts there will most definitely be deterioration in the state of the borrowing banks mortgage book. This will in turn have an effect on the lending banks eagerness to loan out money and in turn have a negative effect on the LIBOR rate as it will rise to reflect the state of the market.
There is another way that banks achieve funding for their daily dealings. Income from their loan books and retail deposits are also used for mortgages and loans. This is how some banks have been able to keep afloat during the recent crisis and it is indeed true to say that the competition that now exists for investments is every bit as intense as it was for mortgages just a few years back.
The drop in rates will mean that the income derived from borrowers will plummet, although banks will continue to grapple for investment business. Therefore the bank's profits will droop and their recovery will be made slower. As the banks fight for investment, the rates drop even below the LIBOR rate, meaning that the only way for banks to get liquid funds is through retail business. In that respect, LIBOR must then drop far enough to be attractive to banks in comparison with the cost of getting in retail business.
To summarise, there is little doubt that the government's actions have boosted confidence levels and created a positive impact on the money market. However there is still a long way to go, and many more challenges to overcome, and the cash injection and reduction in interest rates, although remedial, will still have a few nasty side effects. The irony is, as this article is written, LIBOR has gone back up to 5.65%, so who knows what to expect!

Article Source: http://www.alltopinfo.com

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