Open Discussion: Interest Rates, Mortgages, Savings Rates, and the Banking Industry

[Jake Rickman]

TCLA is trialling a new approach to facilitating commercial awareness among the TCLA community. Based on this week's commercial news article, we want to encourage the community to actively engage with each other so that we can all improve our commercial awareness.

With the following articles in mind, consider the prompt below:

• Reuters, “Central bank surprises see June become bumper 2023 rate hike month”;
• Reuters, “UK mortgage rates rise again, turning screw on homeowners and buyers”; and
• BBC, “Bank bosses told to explain low savings rates”.

“How might the current economic climate create new challenges and opportunities for the banking industry? Why is this relevant for the commercial legal sector?”.

When answering this prompt, you may find it helpful to approach it from the following perspectives:

• What does this story mean for the law firm’s clients?
• How does this story directly impact the law firm’s business?

The first five responses to the thread will get one month of TCLA Bronze membership for free. The only condition is that your post makes a genuine effort to answer the prompt as you might in an application or interview question.

Finally, there are no right (or wrong!) answers. The important thing is to refine our approach to commercial awareness more generally, which requires practice.

(Separately, we will be considering this prompt in more detail during next week's inaugural Commercial Awareness Office Hours. All are welcome to attend — click here to sign up).

 

[simran228]

High interest rates mean that consumers and businesses are less likely to borrow funds since the cost of borrowing is very high. This means that there will be a decrease in debt financing leading to less investments. According to YouGov data, 40 per cent of SMEs (small and medium-sized enterprises) had to stop or pause an area of their business due to a lack of funding over the last couple of years and 39 per cent of SMEs surveyed said they were unable to access funding because it was too expensive. Although banks may lend less, the higher interest rates will ultimately benefit the bank who will receive higher interest rates. However, lack of borrowing and investment will lead to less expansion and deals and commercial law firms will see a decrease in revenue. Global mergers and acquisitions (M&A) activity fell 36% year-on-year in the second quarter. This decrease in sales will lead to a decrease in profit, harming the law firm.

There is also an increase in defaults because consumers and businesses are unable to pay higher interest rates. This can lead to bankruptcies for individuals and insolvencies for businesses. Insolvencies have increased in recent months, reaching over 2,500 in May this year which is 40 per cent higher than May last year. A clear example of higher interest rates harming businesses is seen with Thames Water. Thames Water and its holding companies have total gross borrowings of £15.9bn and Thames Water's current debt amounts to 80% of the value of the business. Interest payments on more than half of Thames' debt rise with inflation which has pushed the company to the brink. This is harming banks who may have to result repossessing and selling securities. This presents further difficulty, especially in residential mortgages with homeowners selling at discount prices. Figures by estate agent Zoopla show that 42 per cent of sellers are accepting discounts over five per cent on the asking price to secure a sale which is the biggest discount recorded by the estate agent since 2018. This increase in defaults and insolvencies may bring in revenue for a law firm's insolvency and restructuring department. This work will include working with administrators, creditors and possibly selling parts of the business. There may also be an increase in revenue for the employment department if there will be a large number of lay-offs. Businesses may struggle to pay employee wages and law firms may have to negotiate severance contracts for these employees. In this way, a law firm's insolvency and restructuring department as well as its employment department may see an increase in revenue, leading to an increase in profits for law firms.

 

[ThisBarbieWantsToBeALawyer]

I’m not very confident with my commercial knowledge and applying it to law but I thought I’d give it a go…

Given the high interest rates have been caused by inflation rather than economic growth one challenge retail banks in particular may encounter is a reduction in overall profit. The increased interest rates although beneficial to banks may also encourage the defaulting of loans as consumers struggle to keep up with the high interest rates and soaring costs of living. Additionally, as customers are yet to see the benefits of the increased rates on their savings some customers may be tempted to repay their loans in full instead. This could potentially affect how banks plan their interest management risk.

For commercial law firms finance teams of those representing retail banks may decide to advise their clients on different ways of restructuring interest risk and handling loan defaults . This could be done through exclusive advisory reports or emails. Another option could be leveraging legal tech or the use of slightly cheaper legal personnel such as paralegals or trainees to keep costs down amidst the rising costs of outsourcing work for businesses.

I still have a long way to go but I’m looking forward to the new series and seeing my improvement.

 

[emily24]

One of the biggest challenges to the banking industry following interest rate hikes is the increased cost of borrowing. Over the past decade, following the 2008 financial crisis, companies were able to borrow cheaply off of low interest rates. Because of the macroeconomic factors and geopolitics, this has drastically changed, and now companies are not able to service debt as easily as before. This couples with the risk of defaulting. We currently saw the series of mid-size regional banks go under (e.g. Silicon Valley Bank). This has prompted banks to tighten access to loans, both B2B and B2C, as well as tighten trade between banks because of the risk of a fellow bank defaulting and impacting its own finances.

While this may be decrease the level of investment of companies, it alternatively may cause an increase in currency (forex trading). One example is the carry trade Berkshire Hathaway conducted on the USD/JPY currency pair through the issuance of Yen bonds. This allowed BH to ride the currency as it got stronger. This could see other commercial players increasing foreign investment and their role in the forex market. Especially with countries such as Latin America experiencing stronger currencies than the GBP.

There are endless facets of the commercial legal sector that are impacted by the current economic climate. While we have seen a decrease in M&A growth, recent announcement of mergers between A&O and Shearman & Sterling, and Vodafone and Three, show companies willingness to invest in undertakings that will drive profit in the long-term. Because of the jump in mortgage rates, commercial real estate is likely to stagger in growth but may encourage project finance and investment into developing countries. Employment and pension lawyers will look at the effect on wage growth and ESPPs and pension schemes (and their security in the event of insolvency).

 

[LibbyH]

TCLA is trialling a new approach to facilitating commercial awareness among the TCLA community. Based on this week's commercial news article, we want to encourage the community to actively engage with each other so that we can all improve our commercial awareness.

With the following articles in mind, consider the prompt below:

• Reuters, “Central bank surprises see June become bumper 2023 rate hike month”;
• Reuters, “UK mortgage rates rise again, turning screw on homeowners and buyers”; and
• BBC, “Bank bosses told to explain low savings rates”.

“How might the current economic climate create new challenges and opportunities for the banking industry? Why is this relevant for the commercial legal sector?”.

When answering this prompt, you may find it helpful to approach it from the following perspectives:

• What does this story mean for the law firm’s clients?
• How does this story directly impact the law firm’s business?

The first five responses to the thread will get one month of TCLA Bronze membership for free. The only condition is that your post makes a genuine effort to answer the prompt as you might in an application or interview question.

Finally, there are no right (or wrong!) answers. The important thing is to refine our approach to commercial awareness more generally, which requires practice.

(Separately, we will be considering this prompt in more detail during next week's inaugural Commercial Awareness Office Hours. All are welcome to attend — click here to sign up).

The current economic client climate of stubborn inflation and hiking interest rates has led to an increase in mortgage rates, more expensive borrowing, and less disposable income for customers. This interest rate hike is aimed at slowing consumer spending, allowing the rate of inflation to cool. However, the intense rate hikes present challenges for the baking industry because fewer investors or consumers will be willing to borrow while rates remain so high and it is uncertain when they will come down away. Moreover, the baking industry has the tricky balancing act of ensuring that saving rates are also increasing so that savings are not eroded by inflation and people are encouraged to save. The current issue of bank being slow to increase savings rates has meant that the FCA is now hot on their heels about increasing rates. However, while increased interest rates make borrowing expensive, banks typically benefit from the rate hike with increased profits. Further, banks could capitalise on these profits to become more competitive. The increase in interest rates and relatively slow increase in saving rates provides a potential opportunity for the banks to offer more competitive saving rates, coupled with easier ways of switching accounts, in an effort to be more competitive and increase custom. On a more global outlook, banks in China have seen interest rates come down slightly, this could make Chinese banks more attractive for investors looking to borrow are more favourable rates.

In terms of the legal sector, this is particularly relevant because inflation and interest rates directly impact a lot of law firms' clients, which are often banks. Firstly, there is an opportunity for the regulatory lawyers to be advising banks through this tricky macroeconomic climate, especially given the FCA is looking into banks' savings rates. Secondly, the effect of having expensive borrowing means delayed investments, impacting areas such as M&A deals, which have already slowed down in Q1 this year (ONS). However, for firms with high liquidity, there could be an opportunity for stressed, distressed or insolvent M&A. The increase in interest rates means the payment on loans is more expensive, which is particularly troubling for firms already under financial stress, as it puts pressure on their liquidity levels. This could lead some businesses that are on the brink of insolvency to go under. Hence, insolvency and restructuring lawyers could have more work on their hands in an attempt to save businesses that are in administration.

 

[Jake Rickman]

High interest rates mean that consumers and businesses are less likely to borrow funds since the cost of borrowing is very high. This means that there will be a decrease in debt financing leading to less investments. According to YouGov data, 40 per cent of SMEs (small and medium-sized enterprises) had to stop or pause an area of their business due to a lack of funding over the last couple of years and 39 per cent of SMEs surveyed said they were unable to access funding because it was too expensive. Although banks may lend less, the higher interest rates will ultimately benefit the bank who will receive higher interest rates. However, lack of borrowing and investment will lead to less expansion and deals and commercial law firms will see a decrease in revenue. Global mergers and acquisitions (M&A) activity fell 36% year-on-year in the second quarter. This decrease in sales will lead to a decrease in profit, harming the law firm.

There is also an increase in defaults because consumers and businesses are unable to pay higher interest rates. This can lead to bankruptcies for individuals and insolvencies for businesses. Insolvencies have increased in recent months, reaching over 2,500 in May this year which is 40 per cent higher than May last year. A clear example of higher interest rates harming businesses is seen with Thames Water. Thames Water and its holding companies have total gross borrowings of £15.9bn and Thames Water's current debt amounts to 80% of the value of the business. Interest payments on more than half of Thames' debt rise with inflation which has pushed the company to the brink. This is harming banks who may have to result repossessing and selling securities. This presents further difficulty, especially in residential mortgages with homeowners selling at discount prices. Figures by estate agent Zoopla show that 42 per cent of sellers are accepting discounts over five per cent on the asking price to secure a sale which is the biggest discount recorded by the estate agent since 2018. This increase in defaults and insolvencies may bring in revenue for a law firm's insolvency and restructuring department. This work will include working with administrators, creditors and possibly selling parts of the business. There may also be an increase in revenue for the employment department if there will be a large number of lay-offs. Businesses may struggle to pay employee wages and law firms may have to negotiate severance contracts for these employees. In this way, a law firm's insolvency and restructuring department as well as its employment department may see an increase in revenue, leading to an increase in profits for law firms.

I think this is good. Your example with Thames Water is a great example of applying your analysis.

If I had any feedback, it would be to try and structure your argument in a more linear way, rather than try and capture as many possible effects of interest rates on the markets. The prompt asked us to consider the impact of current economic conditions on banks — and the resultant impact on commercial firms — which you did do in addition to other aspects of the economy. A more narrow and confined analysis would be easier for interviewers to follow in an interview setting.

But well done on being the first to comment what was a solid survey of the impact of rate rises on various parts of the economy.

 

[Jake Rickman]

I’m not very confident with my commercial knowledge and applying it to law but I thought I’d give it a go…

Given the high interest rates have been caused by inflation rather than economic growth one challenge retail banks in particular may encounter is a reduction in overall profit. The increased interest rates although beneficial to banks may also encourage the defaulting of loans as consumers struggle to keep up with the high interest rates and soaring costs of living. Additionally, as customers are yet to see the benefits of the increased rates on their savings some customers may be tempted to repay their loans in full instead. This could potentially affect how banks plan their interest management risk.

For commercial law firms finance teams of those representing retail banks may decide to advise their clients on different ways of restructuring interest risk and handling loan defaults . This could be done through exclusive advisory reports or emails. Another option could be leveraging legal tech or the use of slightly cheaper legal personnel such as paralegals or trainees to keep costs down amidst the rising costs of outsourcing work for businesses.

I still have a long way to go but I’m looking forward to the new series and seeing my improvement.

I think this is a strong attempt!

I like how you applied it to law firms. This is good and indicative of the sort of approach to be encouraged more generally.

In an interview setting, you may find that your interviewer follows up on certain submissions with counterpoints. For instance, you say that increase in interest rates may hit overall profits. Don't be surprised if an interviewer asks you to account for the fact that increase interest rates in the short-term ought to increase profits, especially if banks are not increasing the rate at which they pay savers banking with them. (E.g., if in 2021, banks offer commercial and retail savers 1% in annual interest rates to bank with them and charge borrowers 3% p.a. for loans, banks obtain a 2% spread, which they collect as profit. But in 2023, if banks still offer 1% to savers but charge 8% to borrowers, the spread is now 7%, which is nearly four times more profit).

But I think you would be right to point out that (as you seem to be implying here) increased rates across the board will lead to a net slowdown of borrowing activity, which, when combined with increased default rates, may offset any short-term profits banks obtain from increased spreads between what they offer savers and what they charge borrowers.

 

[Jake Rickman]

One of the biggest challenges to the banking industry following interest rate hikes is the increased cost of borrowing. Over the past decade, following the 2008 financial crisis, companies were able to borrow cheaply off of low interest rates. Because of the macroeconomic factors and geopolitics, this has drastically changed, and now companies are not able to service debt as easily as before. This couples with the risk of defaulting. We currently saw the series of mid-size regional banks go under (e.g. Silicon Valley Bank). This has prompted banks to tighten access to loans, both B2B and B2C, as well as tighten trade between banks because of the risk of a fellow bank defaulting and impacting its own finances.

While this may be decrease the level of investment of companies, it alternatively may cause an increase in currency (forex trading). One example is the carry trade Berkshire Hathaway conducted on the USD/JPY currency pair through the issuance of Yen bonds. This allowed BH to ride the currency as it got stronger. This could see other commercial players increasing foreign investment and their role in the forex market. Especially with countries such as Latin America experiencing stronger currencies than the GBP.

There are endless facets of the commercial legal sector that are impacted by the current economic climate. While we have seen a decrease in M&A growth, recent announcement of mergers between A&O and Shearman & Sterling, and Vodafone and Three, show companies willingness to invest in undertakings that will drive profit in the long-term. Because of the jump in mortgage rates, commercial real estate is likely to stagger in growth but may encourage project finance and investment into developing countries. Employment and pension lawyers will look at the effect on wage growth and ESPPs and pension schemes (and their security in the event of insolvency).

Strong answer! Your forex point is a very interesting one, and not something I had at all considered. Well done!

Don't be afraid to tease out some of your points in more detail. For instance, how might increased rates encourage project finance investments in developing countries? Alternatively, be prepared for pushback in an interview setting because interviewers want to see how you think on your feet. A counterpoint to yours might be to ask why lenders would lend on inherently riskier projects (as the case is when investing in emerging markets) when they can obtain competitive yields lending to entities deemed more creditworthy in OECD economies.

 

[Jake Rickman]

The current economic client climate of stubborn inflation and hiking interest rates has led to an increase in mortgage rates, more expensive borrowing, and less disposable income for customers. This interest rate hike is aimed at slowing consumer spending, allowing the rate of inflation to cool. However, the intense rate hikes present challenges for the baking industry because fewer investors or consumers will be willing to borrow while rates remain so high and it is uncertain when they will come down away. Moreover, the baking industry has the tricky balancing act of ensuring that saving rates are also increasing so that savings are not eroded by inflation and people are encouraged to save. The current issue of bank being slow to increase savings rates has meant that the FCA is now hot on their heels about increasing rates. However, while increased interest rates make borrowing expensive, banks typically benefit from the rate hike with increased profits. Further, banks could capitalise on these profits to become more competitive. The increase in interest rates and relatively slow increase in saving rates provides a potential opportunity for the banks to offer more competitive saving rates, coupled with easier ways of switching accounts, in an effort to be more competitive and increase custom. On a more global outlook, banks in China have seen interest rates come down slightly, this could make Chinese banks more attractive for investors looking to borrow are more favourable rates.

In terms of the legal sector, this is particularly relevant because inflation and interest rates directly impact a lot of law firms' clients, which are often banks. Firstly, there is an opportunity for the regulatory lawyers to be advising banks through this tricky macroeconomic climate, especially given the FCA is looking into banks' savings rates. Secondly, the effect of having expensive borrowing means delayed investments, impacting areas such as M&A deals, which have already slowed down in Q1 this year (ONS). However, for firms with high liquidity, there could be an opportunity for stressed, distressed or insolvent M&A. The increase in interest rates means the payment on loans is more expensive, which is particularly troubling for firms already under financial stress, as it puts pressure on their liquidity levels. This could lead some businesses that are on the brink of insolvency to go under. Hence, insolvency and restructuring lawyers could have more work on their hands in an attempt to save businesses that are in administration.

You managed to zero in on the "How is this relevant for commercial law firms" factor I had in mind. Namely, that banks will look to their financial regulatory teams to advise them on how to navigate the scrutiny they are now facing from the FCA and the government more generally. Well done!

Generally, I think this is a wide-ranging analysis, which shows you have a broad understanding of the various commercial factors at play across the commercial world. That said, do not be afraid to take a more narrow approach that looks more closely at a single thread you have picked up here. This will allow you to get deeper into the factors at play. For instance, looking just at the relationship between savings rates and FCA scrutiny.

 

[Freezinge]

You've mentioned the potential opportunities for banks to become more competitive, offering better savings rates and easier account-switching options. This could indeed benefit consumers and drive competition within the industry.
Additionally, your insights into the legal sector's relevance in this economic context are spot on. Regulatory lawyers advising banks through these times and the potential impact on M&A deals make for fascinating discussions.
As you've rightly pointed out, a more focused analysis of specific threads within this complex web of factors could provide even deeper insights. Keep up the great work in these discussions, and for all financial matters, I suggest you consult with Mortgage Advice Hull to navigate these complex economic waters with confidence.