The banks are ripping us off

It's getting cheaper for banks to borrow, but not for you and me. John Fitzsimons reveals how the banks are ripping us off.

The banks are feeling a bit defensive at the moment. After a fair bit of press coverage on how - despite huge cuts in the Base Rate - new mortgage deals remain expensive, they have decided to try to justify their position.

Last week, the British Bankers Association - a trade body for banks, funnily enough - published a factsheet called Your Mortgage and the Markets explaining why, although it may seem like banks are profiting hugely by pricing their mortgages much higher than they need to, actually they're not.

It is the second time lenders have been forced to defind how they price their mortgages, after a similar publication from a second trade body, the Council of Mortgage Lenders, a couple of months ago.

I'm not surprised that they feel they have to explain themselves.

Cast your mind back a year or so ago to when Bank Base Rate first started falling to its current record low. Lenders would pull their entire range of trackers before a Base Rate decision, only to release a new, slightly more expensive range, a few days later - when it was actually cheaper for them to borrow money from the Bank of England!

The explanation? Banks don't just borrow funds from the Bank of England. They borrow from each other. And actually, nowadays, the banks were quick to explain, it is the LIBOR rate (the rate at which banks lend to each other) that is the crucial factor in determining the interest rates of loans and mortgages. And as that wasn't moving, tracker rates wouldn't.

Now of course LIBOR has fallen as well, so that it is barely any higher than the Base Rate, and surprise surprise, the banks have changed their tune.

Here's what they're saying now.

The banks' explanation

According to the British Bankers Association, the factors that governed the cost of mortgages until recently no longer apply.

The banks argue that the Bank Base Rate, LIBOR and swap rates (traditionally the mechanism by which lenders secured cash for fixed rate mortgages) are no longer indicators - the rates offered to savers are apparently a better guide.

This is because, they say, with the wholesale and securitisation markets effectively closed, banks are forced to rely on raising money through savings accounts, which is a pretty expensive method at the best of times. Add in the fact that all banks are in the same boat, competing for the same savings business, and you can see why costs might start to creep up. 

Bumping up the margins

But that doesn't mean you can simply dismiss things like LIBOR and swap rates as indicators of where mortgage pricing should be. They may not be the be all and end all, but they remain very important factors.

And they also shine the light on just how big a cut the banks are taking at the moment, a fact brilliantly outlined by some research from lovemoney.com partner, Moneyfacts.

Let's start with the average two year mortgage - forever and a day the favourite mortgage of Brits. In September 2007, for a 75% loan-to-value mortgage, the average rate was about 0.18 percentage points above swap rates. A year later, that margin had increased to 0.7 percentage points.

Today, it stands at an extraordinary 2.79 percentage points above the swap rates.

The position is even worse with high loan-to-value mortgages. With a 90% mortgage, in September 2007, that margin stood at just 0.02 percentage points. By last September it had reached 1.34 percentage points. And last month it stood at a whopping 4.25 percentage points above swap rates. So they're typically making more than 212 times as much profit on the funds they borrow using swap rates, than they were just two years ago!

No wonder the banks want us to ignore swap rates!

It's the liquidity stupid!

The main reason the banks are taking such a big cut, in my view, is actually hinted at in the Your Mortgage and the Markets factsheet: namely, liquidity.

The banks have already, on the whole, had their balance sheets decimated by the credit crunch, and need to rebuild them. And the simplest way to do that is to have higher margins on their mortgage products.

However, they are also under huge regulatory pressure to improve their liquidity position above and beyond what they would likely consider sufficient, thanks to new rules from the FSA.

Indeed, according to the FSA itself, these rules could hit the banks' profits to the tune of nearly £8bn. And that is only likely to lead to even bigger margins, giving us customers an even more raw deal than we are already 'enjoying'.

The banks are right to try to improve all of our understanding of the factors behind the pricing of mortgages - a bit of transparency, after the incomprehensibility of the CDO era, is no bad thing.

But these constant proclamations of innocence and justification merely serve to highlight just what they are doing - factoring massive margins into their mortgage pricing, to bump up their balance sheets.

It's the borrowers of today that are paying for the mistakes the banks made yesterday, and it's not on.

More: Don't go for a two-year tracker! | Why Vince Cable will kill the housing market