You have to wonder what is going on in the UK banking sector. With scant regard, the banks have pumped out mortgages, thus fueling the greatest and most dangerous housing bubble in the history of this country. At the same time, personal sector debt, which almost entirely held by banks, has exploded, such that a third of all unsecured debt in Europe is concentrated in the UK. This is risk taking at its most extreme; pushing out debt that is either unsecured or collateralized on blatantly overvalued assets.
But how have the banks priced all this risk taking. Take a look at the chart above, which follows the movements of three key interest rates; overdrafts, credit cards and mortgages. The data comes from the Bank of England website and it reports average interest rates for each product for the UK banking sector as a whole.
Recently, the Bank of England has been raising interest rates. So how have these interest rates been affected by the change in monetary policy. The mortgage rate appears to have adjusted as expected; it has increased by around 1.7 percent. Likewise, overdraft rates have increased by just under 3 percent. However, the interest rate on credit cards has actually fallen by almost 3 percent.
In theory, interest rates should reflect risk. Thus, it would appear that back in 2004, UK banks thought that overdrafts were more risky than credit cards, but now it is the other way around. Moreover, the turnaround in relative risk is huge.
Given that credit card debt is unsecured debt, why would banks be reducing interest rates when all other interest rates are rising? Could it be that the banks are beginning to get a little nervous about the capacity of credit card debtors to repay. Higher rates could reveal one of the worst kept secrets in banking; that credit card debt is extremely vulnerable and any rise in rates would bring that long ignored house of cards crashing to the ground.
I think this is just one of the many issues which are overlooked by financial experts. Whether the debt is the end product of secured or unsecured loans, the main issue is how to prevent the increasing growth of debt in the society.
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