3.

Describe the situation where banks were reluctant to lend to the public which deteriorated the
economy further.
ROLE OF BANK
Bank lending plays an important role in influencing levels of consumer spending,
investment and economic growth. When bank lend money to consumers and firms, it will create
a situation where the market will be flooded with money that can be spend either on consumer
products or investment. When money flooded the market, it will also create a positive situation
boosting the economy further (Tejvar Petingger, 2012).
TREND LENDING IN UNITED KINGDOM (UK)
Trends in Lending presents the Bank of Englands assessment of the latest developments
in lending to the UK economy. This box reports on lending to the UK real economy in 2012 to
date. The three-month annualised growth rate in the stock of lending to private non-financial
corporations (PNFCs) has been negative in 2012 to date (Chart A).(1) Data from a recently
established Bank of England collection on lending to businesses also point to a contraction in
lending to small and medium-sized enterprises (SMEs) and large firms in 2012, with the rate of
contraction easing slightly.

Chart 1 Lending to UK businesses.

The three-month annualised growth rate in the stock of secured lending to individuals,
while remaining positive in 2012 (Chart B), has fallen since April and in August was at its lowest
since the series began in 1987 Q2. The growth rate in the stock of unsecured lending to
individuals (excluding student loans) on a three-month annualised basis has been negative for the
majority of 2012 to date. A broad description of the measures of lending shown in Charts A and
B. More generally, since the turn of the year the growth rate in the stock of lending (M4 lending
measure) to the household sector and PNFCs has been negative (Chart C).

Chart B Lending to individuals: secured lending and consumer credit.

Chart C

The Funding for Lending Scheme (FLS) was launched by the Bank and the Government
on 13 July 2012. The aim of the FLS is to provide strong incentives for banks, building societies.
and related specialist mortgage lenders to expand lending to UK households and businesses, by
providing term funding at rates below those prevailing in the market at the time. Similarly to the
M4 lending measure, the growth rate in the stock of lending in the FLS-consistent measure of
lending has been subdued in 2012 to date (Chart C). In recent discussions, most major UK
lenders noted that it was too early since the start of the Scheme to assess its impact on lending
volumes. This is consistent with the view that there must be a lag between the announcement of
the Scheme and its potential impact on bank funding costs and lending rates and volumes.
Bank funding costs are likely to be affected before lending rates and volumes.
Participating institutions can access cheaper funding directly following the opening of the
Scheme. And indicative measures of spreads in longer-term wholesale funding markets fell in
2012 Q3. The major UK lenders reported that this reflected the impact of central bank actions,
including those of the European Central Bank and the Bank of England, of which the FLS is one.
For secured lending, for example, the reduction in bank funding costs could then be passed on to
quoted rates on mortgage products which could, in turn, lead to an effect on mortgage approvals.
With the typical lag between mortgage approvals and transactions being around two to four
months, the FLS might first begin to impact on secured lending volumes and data towards the
end of 2012.

SITUATION WHERE BANKS WERE RELUCTANT TO LEND TO THE PUBLIC

CASE 1 :
Adversely, when banks are reluctant to lend money to the public it will definitely
deteriorated the economy (Tejvar Petingger, 2012). There is a good example to explain this
situation with reference to the case of reluctant in bank lending to the United Kingdom(UK)
economy. When bank lending reduced at the start of the credit crunch in 2008 this decline in
bank lending was a significant factor in causing the 2008 recession (Tejvar Petingger, 2012).
Starting year 2002 banks in the UK are giving loans aggresively to the lending market.
There is a big growth in bank lending to the public starting in year 2002 until year 2008. The
effects of this rapid growth in giving our loans to the public has created a situation where banks
has diminished its cash reserve to a low level and create a credit crunch. When bank lending
reduced at the start of the credit crunch in 2008, this decline in bank lending was a significant
factor in causing the 2008 recession (Tejvar Petingger, 2012). This situation can be shown by the
graph below(Chart 1).

Chart 1

This graph shows that lending to UK households and business was growing rapidly
during the period 2000-2008. However, the credit crunch caused a precipitous fall in the growth
of bank lending. Bank lending fell from growth of +10% to negative growth during 2010 and
2011. This fall in bank lending led to lower economic growth. This can be proof by the Chart 2
below, showing a decline in economic growth in UK from 2008 to 2009 (Tejvar Petingger,
2012).

Chart 2
The question now is why did bank lending fall in 2008/2009. There are various reasons to
this question. They are as follows:
1. The credit crunch made it difficult for banks to borrow money. Because banks were short
of cash (liquidity) themselves, they werent able to lend to firms and consumers. Many small
firms have complained they would like to invest, but have been unable to get a loan from
traditional banks (Tejvar Petingger, 2012).
2. Bank Balance Sheets. In the run up to the credit crunch, banks were increasing the amount of
lending. Often they lent money to risky projects on the expectation of continued economic
growth. By 2008, banks were short of cash because they had been too willing to lend. Since
2008, banks have been trying to improve their balance sheets by attracting savings and reducing
the amount they lend (Tejvar Petingger, 2012).

3. Less Demand for loans. After the credit crunch hit, consumers became more reluctant to
borrow and spend, leading to less demand for loans. Also, some firms were put off investing by
the recession because if output falls, investment becomes less attractive (Tejvar Petingger, 2012).
The fall in lending money to the public has resulted a negative impact to the UK
economy. This can be shown by the graph below(Chart 3)

Chart 3
Diagram in Chart 3 showing a fall in AD as a result of lower investment and consumer spending.

1. With lower levels of bank lending, firms were not able to borrow to finance investment.
Therefore, investment in the economy fell considerably. Investment is a component of aggregate
demand (about 16%), so the reduction in investment reduced overall demand and was a factor in
reducing economic growth in the UK (Tejvar Petingger, 2012).
2. Negative Multiplier Effect. With a fall in investment, there can be a knock on effect to other
areas of the economy. If firms cut back on investment, this will cause some unemployment, and
therefore the unemployed will spend less causing an even bigger fall in economic growth
(Tejvar Petingger, 2012).

3. With lower bank lending, consumer spending is also affected. It is harder for consumers to
finance spending on items such as cars and holidays (Tejvar Petingger, 2012).
4. Lower Mortgage lending. The fall in bank lending also affected the UK housing market.
With lower bank lending, it became more difficult for homeowners to get a mortgage. Therefore,
demand for buying a house declined. This caused a 20% fall in house prices during 2008-09.
(House prices may have fallen further, if there hadnt been also a shortage of supply) (Tejvar
Petingger, 2012).
5. Lower mortgage lending particularly hurt first time buyers who struggled to get a
deposit. As a result the proportion of people renting a house in the UK has increased (Tejvar
Petingger, 2012).
6. Increase in the saving ratios. With lower bank lending and other factors, the saving rate in
the UK has increased since 2008 (Tejvar Petingger, 2012).
7. Impact on aggregate supply (LRAS) in the long run. Lower bank lending leads to lower
investment. In the short term, this is primarily seen through lower aggregate demand. But, if
investment is curtailed for a lengthy period, it means that we are not investing in future
productive capacity therefore there will be slower growth in Long run aggregate supply. The
long decline in bank lending and investment has hit the UKs long run trend rate and reduced
future economic growth (Tejvar Petingger, 2012).
The fall in bank lending and negative news about the state of the banking system caused a
big fall in consumer confidence. This fall in consumer confidence contributed to the decline in
spending and economic growth.

CASE 2
The bursting of the housing bubble is the primary caused to the credit crisis. The housing
bubble has four main factors which are low mortgage interest rates, low short-term interest rates,
relaxed standards for mortgage loans and irrational exuberance (Holt, J., 2009).
Subprime crisis also lead by the housing bubbles. Homebuyer who has low
creditworthiness due to high level of debt, a low income, or a poor credit record is called as
subprime borrower. Usually bank would charge higher rate to subprime borrower to compensate
on their lending risk. However during the housing bubbles, bank has lowered the interest rate
charged to the subprime borrower and loosened their mortgage eligibility. This situation has
leaded the inflation and the explosion of the subprime lending has breakdown the housing
bubbles. When subprime borrower unable to make repayment and default, has caused
banks reluctant to lend to the public. As a result, when people has less purchasing power,
they would less spending their money and the impact is to the industry where during U.S.
crisis, nearly 9 million jobs from 2007 to 2009.

4. How can a decline in real estate prices cause deleveraging and a decline in lending?
REAL ESTATE
Real estate are refers to land, as well as any physical property or improvements affixed to
the land, including houses, buildings, landscaping, fencing, wells and other (Investing Answer,
2015). In addition, it also comprised a property of land and the buildings on it as well as the
natural resources of the land including uncultivated flora and fauna, farmed crops and livestock,
water and minerals. real estate can be grouped into three broad categories based on its use:
residential, commercial and industrial. Examples of residential real estate include undeveloped
land, houses, condominiums and town homes. While example of comercial real estate are office
buildings, warehouse and retail store buildings and examples of industrial real estate are
factories, mines, and farma (Investopedia, 2015).
REAL ESTATE PRICES CAUSE DELEVERAGING AND A DECLINE IN LENDING
For a some reason, usually housing bubbles caused by the manipulation, rumours and
expectation of future value.
When a person wants to buy a real estate property, no one can buy with cash money. This
is because the price of real estate are beyond the capability of the buyer where the buyer do not
have enough cash savings in his bank account. This is largely due to the fact that most house
buyers are first time house buyers and are relatively young at age. Then again buying a real
estate is not cheap and a person need bank loan to help him buy a real estate property.
A decline in real estate prices can cause deleveraging and a decline in lending. This
situation has already happened in the United States of America which triggered the financial
crisis in crisis 2007. This is because a large part of the collateral available with the bank against
the loans is in the form of real estate property. The banks had given loans to the subprime
borrowers against the mortgage of their homes (Manoj Singh, 2015).
It all started in In 2001, the United States(U.S.) economy experienced a mild, shortlived recession. To keep recession away, the Federal Reserve lowered the Federal funds rate 11
times - from 6.5% in May 2000 to 1.75% in December 2001 - creating a flood of liquidity in the
economy. Cheap money, once out of the bottle, always looks to be taken for a ride. It found easy

prey in restless bankers - and even more restless borrowers who had no income, no job and no
assets. These subprime borrowers wanted to realize their life's dream of acquiring a home. For
them, holding the hands of a willing banker was a new ray of hope. More home loans, more
home buyers, more appreciation in home prices. It wasn't long before things started to move just
as the cheap money wanted them to (Manoj Singh, 2015).
This environment of easy credit and the upward spiral of home prices made investments
in higher yielding subprime mortgages look like a new rush for gold. The Federal Reserve
continued slashing interest rates, emboldened, perhaps, by continued low inflation despite lower
interest rates. In June 2003, the Federal Reserve lowered interest rates to 1%, the lowest rate in
45 years. The whole financial market started resembling a candy shop where everything was
selling at a huge discount and without any down payment. The entire subprime mortgage market
seemed to encourage those with a sweet tooth for have-it-now investments. Unfortunately, no
one was there to warn about the tummy aches that would follow (Manoj Singh, 2015).
But the bankers thought that it just wasn't enough to lend the candies lying on their
shelves. They decided to repackage candy loans into collateralized debt obligations (CDOs) and
pass on the debt to another candy shop. Soon a big secondary market for originating and
distributing subprime loans developed. To make things merrier, in October 2004, the Securities
Exchange Commission (SEC) relaxed the net capital requirement for five investment banks Goldman Sachs (NYSE:GS), Merrill Lynch (NYSE:MER), Lehman Brothers, Bear Stearns and
Morgan Stanley (NYSE:MS) - which freed them to leverage up to 30-times or even 40-times
their initial investment. Everybody was on a sugar high, feeling as if the cavities were never
going to come (Manoj Singh, 2015).
But, every good item has a bad side, and several of these factors started to emerge
alongside one another. The trouble started when the interest rates started rising and home
ownership reached a saturation point. From June 30, 2004, onward, the Federal Reserve
started raising rates so much that by June 2006, the Federal funds rate had reached 5.25%
(which remained unchanged until August 2007). Then the decline begins (Manoj Singh,
2015).

There were early signs of distress: by 2004, U.S. homeownership had peaked at 70%; no
one was interested in buying property or eating more candy. Then, during the last quarter of
2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction
Index during 2006. Not only were new homes being affected, but many subprime borrowers now
could not withstand the higher interest rates and they started defaulting on their loans (Manoj
Singh, 2015).
This caused 2007 to start with bad news from multiple sources. Every month, one
subprime lender or another was filing for bankruptcy. During February and March 2007, more
than 25 subprime lenders filed for bankruptcy, which was enough to start the tide. In April, wellknown New Century Financial also filed for bankruptcy (Manoj Singh, 2015).
It became apparent in August 2007 that the financial market could not solve the subprime
crisis on its own and the problems spread beyond the United State's borders. The interbank
market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern
Rock, a British bank, had to approach the Bank of England for emergency funding due to a
liquidity problem. By that time, central banks and governments around the world had started
coming together to prevent further financial catastrophe (Manoj Singh, 2015).
In conclusion, during the prices of real estate properties are high and in good demand
from the public, it has created a bubble effect on property demand. To add sour to the bubble
effect the US government has increased interest rates which has resulted to many loan defaulters
and making the bank reserve dry. Thus there has been a decline in lending growth.

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2012, from http://www.economicshelp.org/blog/6571/alevel/importance-of-bank-lendingto-uk-economy
Pettinger, T. (2012). Asymmetric Information Problem. Economics help blog. Retrieved on 17
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