The Council of Mortgage Lenders has recently spoken out to defend its member banks, after some banks were criticised for failing to pass on base rate cuts and were accused of making a profit. The CML insists that its member banks are actually profiteering, and recently released a statement to this effect.

In the statement the CML said: We know the main question will be ‘will lenders pass on any Bank rate cut to mortgages?’.

The wording of the question implies that lenders themselves automatically benefit from any cut in Bank rate, when in fact they don’t. The real cost of funds to lenders is determined not by the Bank base rate, but by their own cost of borrowing. And their cost of borrowing depends on what they need to pay to savers to attract deposits, as well as how much it costs them to borrow from other banks or the money markets, and the costs of holding capital and sufficient liquidity (both of which have heightened importance in the current market environment).

The cost of borrowing from other banks can broadly be gauged by three-month Libor, which in recent years sat within a range of between 0.15% and 0.2% of Bank rate but is now 1.2% above it. Also, in the past, if base rates were expected to fall this would usually be priced in by the markets in advance. So, it does not make commercial sense to insist or expect that lenders automatically ‘pass on’ cuts in Bank rate to borrowers (other than those with Bank rate tracker mortgages) unless and until the cut flows through to an equivalent reduction in their own funding costs.

Even then, it’s important to allow for the fact that in the post-credit crunch environment, where Government and regulators expect lenders to operate lower-risk and higher-capital lending businesses, the pricing of mortgages relative to benchmark rates is highly unlikely to return to the very narrow margins of the pre-crunch era. And lenders will need to take account of the possibility of higher provisioning and losses in an environment of higher arrears and possessions. A decision not to follow a base rate reduction does not imply that the lender is ‘profiteering’.

A number of banks have stated that they will be passing the massive 2% worth of rate cuts on to consumers, but in some cases these may not take effect until December for many mortgages. For some consumers this comes a little too late considering that Christmas is around the corner, although most are relieved to see the rate coming down by such a significant level. The government hopes that the rate cuts will increase spending power and boost the economy, but ultimately this all rests on whether the banks decide to pass on the full rate cuts to consumers.

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