UK financial markets look to be entering a new era of turmoil as top banks are building up their cash reserves to cover the possibility of further losses from the continuing collapse of the sub-prime market. This action could signal worrying times for anyone who has loan balances outstanding, because they are likely to see the cost of them rise in the short term.

In the wholesale financial market the gap between the base rate and percentages being charged on three-month loans is increasing and overnight loan rates are also rising steeply as liquidity begins to dry up. These factors are knocking on into the retail financial markets by forcing an increase in the rates charged by high street banks and building societies on UK loans and mortgages.

The new jitters in the financial markets are primarily due to the risk of a cut in credit ratings to so-called ‘monoline' insurers. These firms operate in relative obscurity on the edge of the financial markets and insure debt instruments, including sub-prime linked securities, giving the investments credit ratings. However, many experts have highlighted that monolines are so exposed to sub-prime meltdown that their own credit ratings could be downgraded. If that happened there would be a knock-on effect for the billions of pounds of securities that they insure, leading to potential further losses for investment banks.

All that uncertainty is forcing high street banks to put more cash aside to cover themselves in case of major hits to their accounts. But, it's not just the fact that banks are upping their liquidity that is adding to increasing loans rates; all high street financial institutions are also being forced to tighten their own lending criteria to prevent any more exposure to potential loan defaulters. Indeed, many banks are now only willing to lend to those whose credit ratings are excellent but do not want to borrow, meaning that those whose credit ratings are poor and desperate to borrow are being declined credit as they are considered too much of a risk.

The rates on secured loans have been steadily increasing over and above the Bank of England rate rises as financial institutions build in more of a margin for to recover losses already incurred, and also to provide a buffer for potential defaulters. With the strict criteria now being imposed on new lending by cautious banks and building societies, it will be a tough time for anyone with less than a perfect credit record who wants to extend their borrowing.

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