Source: Bank of England  Chart 7: Spread of effective mortgage and personal loan rates (new business) to Bank Rate P ersonal loans  30  50  5  PNFCs  100  Chart 8: UK corporate bond spreads  Per cent 6  Basis P oint s 1200 Non-invest ment grade  5  M ortgages  1000  4  800  3  600  2  400 Invest ment grade  1  200  0 2001  2002  2003  2004  2005  2006  2007  0 1998  Source: Bank of England  2000  2002  2004  2006  Source: Bloomberg, Bank of England  Chart 9: Decomposition of UK noninvestment grade corporate bond spreads  Chart 10: Issuance of UK residential mortgage-backed securities  Basis point s  Residual including liquidit y Uncert aint y about default loss Expect ed default loss  £ blns 60  1000 Actu al  50  800  40 600  30 400  `  20 200  10  0  0 2000 2001 2002 2003 2004 2005 2006 2007  -200 1998  2000  2002  2004  2006  Source: Dealogic  Source: Bloomberg, Bank of England  12  BIS Review 149/2007  Chart 11: Gross corporate bond issuance by UK private non-financial companies (all currencies)  Chart 12: Basis between credit spreads on bonds and credit default swaps  £ billions 12  basis point s 150  10  100 Europe  8  50  6  0  4  -50 -100  2  US -150  0 2003  2004  2005  2006  -200  2007  -250  Source: Bank of England Jan.  Apr.
In a similar vein, on the whole, research does better at identifying these “credit channel” mechanisms in the context of particular stressed episodes than in longer-run averages. 11 Be that as it may, it is beyond doubt that there has recently been an adverse shock to bank balance sheets – involving capital, liquidity, and a potent “asymmetric” information mechanism affecting a wide range of banks. I will pick out four elements in the story, involving liquidity, counterparty-credit risk and capital. First, near closure of the capital markets for leveraged loans, conduit and SIV commercial paper, and RMBS has left banks whose business model is “originate and distribute” unexpectedly holding on to loans and, in addition, facing the prospect of having to take assets back on to their balance sheets. The consequent reintermediation is a hit to both capital ratios and liquidity, as the banks have bigger books to fund. For these reasons alone, big picture, banks responded from August onwards by tightening loan terms and hoarding liquidity. But the story does not end there. The second element is that access to resources (uninsured deposits) from outside the banking sector has become more restricted since the summer. While the new risk-transfer instruments have plainly dispersed risks, lack of ex ante disclosure left market participants highly uncertain about the scale and distribution of losses across the banking sector itself. On top of that, open-ended investment vehicles that have (or may have) themselves invested in structured-finance paper have felt compelled to preserve liquidity, to guard against redemption risk.