Secured Loans & the liquidity crisis

When the Bank of England cut its base rate by 0.5%, it was another step in a process that should help would-be borrowers looking for mortgages, secured loans and other kinds of credit.

Since the credit crunch began, the availability of secured loans (and credit of all kinds) has been relatively limited. Secured loans have also become, in general, more expensive.

It's because loan providers have been worried about their own finances, and the finances of other loan providers. Normally, lenders use the debts they own (the money people have borrowed from them) to borrow more money (from other lenders), so they can lend it out (as more secured loans, mortgages, personal loans, or whatever they specialise in).

It actually works a bit like a secured loan - they're securing the loan against the debt they own, so the loan provider lending them the money knows they can afford to pay it back. So it's similar to the way a homeowner can take out a secured loan by securing it against the equity in their property.

The credit crunch disrupted all that, disrupting the secured loans market. Why? Many lenders realised they weren't sure how much of the debt they owned would actually turn back into money. In many cases, they'd bought 'packaged debts', so it was very hard to know what kind of risk each 'pound' of debt carried - a £1 debt that's very unlikely to be repaid isn't really worth a pound!

This made loan providers worry about their own finances. It also made them reluctant to lend to other loan providers who wanted to borrow from them (by using their own debts as collateral). This led to the 'liquidity crisis' - a lack of 'liquid' cash (cash that's available to be spent or lent, rather than tied up in property or other more 'solid' assets). Secured loans became, in general, harder to find and more expensive.

The Bank of England's base rate cut should help reduce the cost of lending and make secured loans more available, but it's not the full story. The Bank's Special Liquidity Scheme, for example, allows banks to 'swap temporarily their high quality mortgage-backed and other securities for UK Treasury Bills'. In other words, it lets them temporarily swap their debts - as long as they're high-quality debts - for Treasury Bills, an excellent source of funding, which they can use to provide secured loans, mortgages, etc.

Then there's the Government push to restore confidence in the banking systems and 'kick-start' all kinds of lending, not just secured loans. As The Times reported, the Bank 'will pump at least £200 billion into the money markets under its existing Special Liquidity Scheme' and the Government 'is also making a further £250 billion available for banks over the next three years to guarantee medium-term debt to help restore confidence and get banks lending to each other again'.

Together, the various initiatives should give loan providers the confidence and the money they need, so they can get back to providing secured loans and other forms of credit to individuals and businesses.