Inflation, it seems, is not a beast that is easily tamed. While the rate of inflation may have marginally declined it has not done so at the rate many anticipated or are hoping for. Many are now pricing in two more hikes in the US and Jeremy Hunt has already publicly stated that the Bank of England must do what it takes to quell inflation.

The cost-of-living crisis, brought on by higher inflation and rising interest rates in terms of borrowing costs, has exposed the heightened vulnerabilities of lenders with material exposures in long-term, fixed rate assets that are fuelled by shorter-term, less stable funding. As interest rates rise, many lenders have seen falls in asset values, while also being exposed to the changing risk appetites of funders who may flee at the first sign of trouble.

For those whose funding relies on retail deposits, another challenge looms. Thinning margins mean wholesale money may again be attractive as a source of funding and competition. Perhaps more existential is that any inability to keep pace with the most competitive deposit accounts could see consumers move money very quickly. In an age of social media, the news of deposit outflows can quickly spiral into something far more unpleasant.

This last point is interesting because it is not hypothetical. We have already seen the effect in the US of what a new digital savings account can do to the available deposits in a sector. Here too in the UK, new banking challengers with best-buy savings rates have also taken money from less competitive banks and building societies.

Monetary policy, in the shape of rising interest rates, imparts new risks to boards concerning their lending and funding in numerous ways. Reacting to the pressure of rising funding costs and thinning margins can be acute in a market where lenders need to meet market share targets. The result can be to stretch credit policies or rewrite them completely. In times of stress, all of a sudden, what you think is happening and what is actually happening in an organisation can become unaligned.

Having a diversified funding base is the key. We have seen many centralised lenders who have relied on securitisation, turn to alternative funding streams and many have applied for banking licenses to allow them to raise retail deposits. This is not so straight forward for mutuals of course but nevertheless, they are no less impacted by the bigger forces at play here.

As for back books, arrears will start to show as the last batch of short-term fixed rate products written before the inflationary surge comes to an end. A stress test of 3% over SVR might have seemed reasonable back in the day but stubborn inflation will probably exacerbate any trouble in 2024. For now, of course, arrears have barely registered but 2024 will see more distress as product terms taken in a period of historic low rates come to an abrupt end.

The question for lending boardrooms everywhere is how to manage this and be confident that the processes and systems in place from origination to funding are operating in a stressed environment.

The next 24 months will promise more scrutiny and stress for lenders as margins come under pressure. Knowing you have your hand on the tiller and that the ship will perform as you expect will be crucial.

Simon Collingridge, Managing Director UK, Fortrum