Working within the business cycle
A Building Societies Association case study

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Page 4: Downturn and recession

A downturn reflects a slowdown in economic activity as rates of growth fall. This might be triggered by the government acting to try to control inflation or in the case of the latest recession, by disturbance to the world financial markets. As the downturn takes hold it may lead to a recession.

Recession can technically be defined as two successive quarters of negative growth. Fewer goods and services are demanded and created within the economy, leading to a rise in unemployment. With people losing their jobs, mortgage arrears may rise and house prices fall as fewer people are confident they can afford to buy their own home.

During a downturn consumers may not have as much money to save. Building societies use savings to fund mortgage lending to other customers. Therefore, as saving falls, building societies have less money to lend and the mortgage market shrinks.

During the recession in 2008/9, the Bank of England reduced interest rates in an effort to stimulate the economy. The BSA felt that this punished savers and did not help encourage people to save. It therefore campaigned against such low rates. Although rates were cut to 0.5% in March 2009 the lowest rate on record - the Bank of England stopped short of dropping the interest rate to zero.

Depressed economic conditions mean that the profits of banks decline. It also makes building societies less able to pass benefits on to their members. Their balance sheets may shrink in size. For many building societies this simply means standing still for a year or two, for example, not making as many mortgage loans. However, they also need to plan to retain their members so that they are ready for recovery.

In recent years some banks made subprime mortgage loans. These are loans to higher risk customers in return for higher rates of interest. High risk customers may already have debt or a history of missing repayments on credit cards or loans. When many of these borrowers (particularly in the USA) missed their debt repayments and went into arrears, it sparked the recent global financial crisis.

During this difficult time building societies have worked hard to support their members. They do not want them to go into arrears as this does not benefit either the member or the society. Instead they provide help. For example, members are asked to contact their societies if they think that they might not be able to pay their mortgage. A survey conducted for the BSA showed that 97% of people who went into arrears were able to retain their own homes.

Although the level of mortgage arrears in the UK has been rising in the recent recession, the level of arrears as a proportion of total lending by building societies is low compared to the market as a whole.

Building Societies Association | Working within the business cycle