Era of cheap mortgages over says City watchdog

Hector Sants, head of City regulator the Financial Services Authority, predicted the cheap credit era may be over.

He believes that the crisis in the financial markets will force banks to change the way they do business.

They may have to keep more loans on their own books, rather than packaging them up and selling them off, which could raise the cost of borrowing.

Mr Sants said: "In the old days, banks basically kept the risk on their own balance sheet. When they entered into a transaction with the consumer, they kept the risk of that transaction for the life of the transaction... for the life of the mortgage.

"In recent years they have looked to pass that risk on to another party which took it off its own balance sheet... took it away from its own shareholders."

But Mr Sants thinks that lenders could now have to pare back their use of these complex financial systems which have helped to lower loan rates.

They may instead seek to develop longterm relationships with their customers in the wake of the global economic woes sparked by last summer's crisis in the US sub-prime mortgage market.

He told BBC Radio 4's Today Programme: "I don't think markets are ever going to return to the way they were.

"The idea that at some point they will go back to normal is a misnomer. The new 'normal' will be different from the way that markets behaved in the past."

He added: "Banks need to give consideration to how their business models will need to adapt to the changed market circumstances they have seen."

But he warned lenders not to use the credit crunch as an excuse to push up mortgage rates.

"We will be looking for firms to treat their customers fairly in these arguably more difficult times," he added.

The finance chief is to issue his warning to 300 banks and financial institutions in a speech today.

The Bank of England's Monetary Policy Committee cut interest rates to 5.25 per cent from 5.5 per cent this month amid signs that the UK economy is slowing down. Chancellor Alistair Darling-warned yesterday that Britain faced "uncertain times", but he argued that a resilient economy would help weather the economic storm.

Rachel Lomax, the Bank of England's deputy governor, also issued a gloomy prediction, stressing that the current financial woes were "surely... the largest ever peacetime liquidity crisis".

She forecast that the threat of inflation and the global credit squeeze would mean the UK needed to grow at below normal rates for the next two years.

She is the fourth member of the monetary policy committee to raise concerns about the economic outlook.

Experts say the MPC could be limited in its ability to cut interest rates, even if the economy slows, because of the need to keep inflation under control.