BoE tells banks not to relax lending standards

The Bank of England yesterday warned commercial banks not to let their credit officers "walk on water" and relax their lending standards in the expectation that bad debts would continue to remain low.

Michael Foot, an executive director of the Bank of England, also cautioned banks against basing lending decisions on assumptions that the next economic downturn would be like the last one.

He advised banks not to abandon their minimum margins on pricing just because their rivals had.

Neither should they sacrifice covenants, which give them the right to intervene in the affairs of a borrower and suggest remedial action, because it would leave them vulnerable to the accuracy of their original lending decision.

He also said banks should resist being influenced by shifting sentiment towards "hot" markets, products or industries. "One excellent discipline here is to regularly ask yourself why you think more about the economics and risks of mandate X than your competitors.

"No satisfactory answer to this very basic question maybe means you don't want that mandate after all."

Banks were crippled by soaring bad debt provisions in the early 1990s when economic recession coincided with the end of a housing boom. After battling to cut these provisions, banks are experiencing lower bad debts as a result of the economic recovery and in recent months the Bank of England has been warning banks not to be duped into lending money more freely because their bad debts have fallen.

This could also happen because banks are beginning to assume that the low-inflation environment will mean that swings in nominal interest rates may be less severe than in previous decades.

Mr Foot said it was still a matter of debate whether this would actually reduce bad debts. "But, even it if it does, the point I am making is that the bad debt experience of the last three years had been by any standards exceptionally low; and it is exactly at such points in the lending cycle in the past that credit officers begin to think that 'it is always going to be like this' or in the worst cases, that they can walk on water."

He urged banks not to ignore the information of the early 1990s when recession hit and interest rates soared.

It would be far too simplistic to assume that all default risk would be eliminated by more stable macro-economic conditions.

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