Why do UK banks seem so optimistic despite the cost of living crisis? | Banking

Britain’s banking bosses exuded an unexpected air of calm as they released second quarter results last week, defying wider concern over the cost of living crisis and its impact on businesses and consumers.

Major high street lenders including NatWest, Barclays, Lloyds and HSBC have largely ignored concerns about potential defaults linked to weaker economic forecasts, with most announcing new payouts to investors and instead releasing money that they had previously set aside for bad debts.

So why are banks so optimistic, given the mounting pressure on household finances? We take a closer look at what we learned during the second quarter earnings season.

Vulnerable customers are in trouble, but they haven’t borrowed from the big banks

Lenders have been candid about the impact 40 years of high inflation is having on their poorest customers.

Lloyds said around 1% of its account holders were “really struggling to make ends meet”, while NatWest revealed the lowest income customers were already sliding into energy poverty – defined as spending more than 10% of their income in energy bills.

However, banks said this did not lead to an increase in defaults, as few of these vulnerable customers actually borrow from high street banks. This may be due to the fact that they would not have qualified for these loans in the first place.

This means that, rather than setting aside money for bad debts, banks are able to take less costly measures to deal with the cost of living crisis, including referring struggling customers to consumer charities or creating online budgeting tools.

Customers reduce expenses and some save more

Banking executives have said many customers are actually in better financial shape than they were before the Covid pandemic. This is due to lower spending during the shutdowns, which has helped borrowers pay down debt and accumulate savings.

“They are entering this environment in much better financial shape than they would have been before the pandemic,” said Anna Cross, chief financial officer of Barclays.

Although NatWest said most customers spend about 20-30% more on “critical items” such as utilities and fuel, consumers seem to be taking matters into their own hands. Lloyds said many were cutting subscription services such as Netflix and avoiding big-ticket items including appliances and computers.

Cross said Barclays was watching for changes in behavior, such as a new reliance on overdrafts or cash withdrawals from credit cards, but hadn’t yet seen any red flags. “I think it’s because of the rational change around their own spending habits. But what we also saw during Covid was a real accumulation of savings by consumers and even businesses, and the [subsequent] repayment of unsecured debt.

NatWest boss Alison Rose added that nine of her own bank’s 10 mortgage borrowers had also hedged against inflation and subsequent interest rate hikes, by taking out fixed rates.

Rising interest rates support bank income

Even though some banks such as Lloyds Banking Group have set aside additional cash to help cushion the blow of potential defaults, these costs have been more than offset by higher revenues from rising interest rates.

UK interest rates, which have hovered near record highs for most of the past decade, have risen from 0.25% last year to 1.25% today. This means banks are able to charge borrowers more for loans and mortgages, thereby increasing their net interest margin – a key measure of profitability and growth.

Bank of England policymakers are expected to raise interest rates again on Thursday, and lenders including Barclays believe they could reach 2.5% by the end of the year.

This could lead to slower growth in house prices and mortgages. However, Lloyds said it still expects its own lending rate to rise to single digits over the next 12 to 18 months.

Barclays also appears to be benefiting from the interest rate outlook, having bought specialist lender Kensington Mortgages in a £2.3bn deal last month.

Low unemployment rate gives hope to banks

Lloyds has revealed one of the more pessimistic forecasts: predicting little to no growth in UK gross domestic product over the rest of the year, and a mere 0.5% increase in 2023. This forecast will be in part affected by inflation peaking at 10-11%, before declining in the second half of next year, the bank said.

However, Lloyds executives said they were still encouraged by the forecast for the UK unemployment rate, which is expected to remain stable at just under 4%.

“It’s a very different shock we’re going through, compared to the last 25 years of UK history. But there’s a lot to be learned from some of these previous shocks the economy has been through,” said Charlie Nunn, managing director of Lloyds.

He said it was worth examining how emerging economies had faced similar economic situations in recent years. “I draw a lot of personal experience from these experiences in places like Mexico, India, other parts of Asia, where we’ve seen really significant inflation, but employment rates [were] high. There is a lot to learn from this. »

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