The far reaching effects of the credit crisis

February 28th, 2008

There are signs that the credit crunch and its various effects on the credit markets could be much more long term than previously thought. Lending models that have financed so much cheap credit are now being entirely re-built as banks reel from the sub prime crisis.

The “originate and distribute” model, under which banks wrote loans but then sold on the assets to other institutions, has fed market worries since the start of the credit crunch, as there is little clarity about where risk lies.

The Financial Services Authority’s chief executive, Hector Sants, told BBC radio, ‘I don’t think markets are ever going to return to the way they were. The idea that at some point they will go back to normal, I think, is a misnomer.’

‘We still believe that (packaging loans and selling them on) will be doable, but probably using simpler and more understandable vehicles which investors who are buying this dispersed risk can have greater confidence in,’ he said.

Sants’ comments revived concerns among some industry watchers that the regulator could take aim at the originate and distribute model — for example, by including off-balance sheet vehicles in capital requirements, a move which would batter already vulnerable financial positions for many lenders. Failing to allow banks to free up capital for more loans, moreover, would have a significant impact on the wider economy.

‘This strategic rebalancing may further affect the availability and price of credit, but from a regulator’s point of view that is not necessarily a bad thing,’ Sants said.

‘Easy credit is not necessarily good for either consumers or the economy in the long term.’

Delivering a swipe just as banks come to publish the bonuses, benefits and salaries received by top executives, Sants also criticised lenders’ remuneration systems, suggesting that the bonus culture may encourage excessive risk taking.

“There is a risk that the remuneration structures are too short-term and that they do incentivise behaviour which is not helpful in terms of maintaining long-term financial stability.”

The biggest British casualty of the credit crunch has been mortgage lender Northern Rock , whose woes shook the banking system last September. The firm suffered a run on deposits, and it was finally nationalised by the government earlier this month.

The FSA is due to present an internal report on the Northern Rock debacle to the FSA board on Thursday, though the full review of its actions during the mortgage bank’s crisis will not be made public until mid-March.

Sants, whose FSA has come under fire for its role in the Northern Rock saga, said the regulator’s supervision of the mortgage lender was ‘not of sufficient intensity and rigour’ and it did not do enough to challenge the board on risk management.

‘We were clear from the outset that the standard of supervision of Northern Rock was not acceptable to us,’ he said. ‘That needs to be addressed.’

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The far reaching effects of the credit crisis

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