CML news & views

Today, we publish our submission to the Financial Services Authority (FSA) on the future of mortgage regulation.

In doing so, we are stressing that the CML – and individual lenders – recognise the need for change. But that is not the same as saying that we think there is a need for a radical review of how mortgage lending is regulated. 

Later this month, the FSA is expected to publish a long-awaited discussion paper as part of its mortgage market review. In anticipation of this, we have been consulting members throughout the summer to see how they think mortgage regulation should be modified. 

That has helped clarify our understanding of how lenders view the future of regulation and where the focus of change should be. We are publishing our submission today not to pre-judge the FSA's forthcoming paper but as a contribution to the continuing debate.

We understand that the FSA has set three key goals for its mortgage market review:

• to ensure there is a sustainable, vibrant and competitive UK mortgage market;
• to ensure there is a predictable, transparent regulatory regime; and
• to deliver positive outcomes for consumers.

Those are lofty goals, but they are the right ones – and we support the regulator’s aspirations. Of crucial importance, however, is how the FSA defines success. An even more fundamental question might be: what sort of regulatory regime can deliver these outcomes? At this stage, there is a considerable risk that intervention as a result of the FSA’s review will produce the wrong outcomes. 

Consumer detriment

We therefore urge caution in the steps taken by the FSA following publication of its forthcoming paper. Any proposed intervention by the regulator should focus on clearly identified causes of consumer detriment or market instability, and we will look closely for evidence that that is the rationale behind any FSA proposals.

Clearly, therefore, we need, from the outset, a proper understanding of what constitutes consumer detriment. In an economic downturn, to equate mortgage arrears with consumer detriment is too simplistic. 

It fails to take into account the value delivered by widespread access to mortgages, meeting people's aspirations to be home-owners, and specialist products for particular customers' financial needs where generally no financial problems arise either for these individuals or for groups of customers.

Successful regulation

What must not be overlooked in the review process is the success of the existing mortgage conduct of business rules, which have worked well in putting in place a clear regulatory structure since they were introduced in 2004. In the intervening five years, the rules have largely served their purpose and do not therefore need substantial revision. 

What we have seen, however, is a failure of prudential supervision and enforcement of the rules in some niche markets. So, improvements could be made based on the practical experience of the last five years.

What we must also not forget is that, prior to the credit crunch, the vast majority of mortgage lenders and brokers acted responsibly in a competitive environment that had provided a range of good, valued products to UK consumers.

Our aim therefore – whether as lenders or as a regulator – should be to encourage a return to those competitive conditions, and not inadvertently perpetuate a malfunctioning market in which there is a smaller number of active lenders, fewer intermediaries offering advice, and a funding shortage resulting in mortgage rationing, particularly for those without a large deposit. It is vital to avoid unnecessary regulatory intervention, and in particular measures that may constrain a mortgage market recovery.

This risk extends to the FSA’s regulatory measures on capital and liquidity, which are being brought forward in parallel with the mortgage market review and are likely to have a considerable impact on the future pricing of mortgages.

Mortgage pricing

It is clear that mortgages will be more expensive in future. We will not see a return to the conditions we saw before 2007, when some loans were priced below the cost of funds. This change is not lenders’ “profiteering,” as some have suggested, but a response to regulatory pressures and other changes, and a less benign economic background.

In assessing the need for regulatory reform, it is important to understand that the financial crisis – and the way firms have responded to developments – have already resulted in fundamental change in the mortgage market affecting the availability and pricing of loans, both now and for the future:

• As well as more expensive mortgages, we will see increased differentiation between different groups of customers, with first-time buyers who represent a higher risk paying more.
• Lending criteria will be less generous, partly reflecting the restricted availability of funding.
• There will be a more intrusive – and more expensive – supervisory approach by the FSA.

Mortgage pricing reflects changed market conditions, as we have sought to explain. The industry is changing in a way that will not be reversed and could be further accentuated by measures introduced as a result of the FSA’s mortgage market review.

The European threat

The risk that regulatory intervention will not address consumer detriment – but will impose unnecessary restrictions and costs – is heightened because there is a danger of coincidental regulatory intervention by the European Commission. The risk arises because the Commission has decided to undertake a review of responsible lending and borrowing in Europe at the same time as the FSA is conducting its own UK market review. 

We have urged the Commission to exercise extreme caution about intervening as there is an increased risk that measures it implements could conflict with, rather than complement, separate proposals from the FSA for the UK mortgage market.

The FSA has already launched a debate about regulating higher-risk mortgage products and practices. We do not believe, however, that the regulator should assume that banning product features – such as high loan-to-value or loan-to-income ratios – or prescribing sales requirements, such as income verification rather than self-certification – addresses potential consumer detriment adequately. 

In current market conditions, product regulation is a blunt tool against past problems that are no longer prevalent.

We have yet to see evidence that capping lending would improve the outcome for consumers or address potential detriment. In reality, lenders are most likely to focus on the balance between higher risk and more mainstream lending, and can be encouraged in this approach if the FSA imposes prudential requirements on firms.

As the regulator is aware, changes to requirements for holding capital and liquidity to compensate for higher-risk mortgages will have a direct effect on the amount of lending firms will do. We must therefore make sure that the cumulative effect of measures is not too onerous or out of proportion to the risk of consumer detriment. 

Unintended consequences

It is also important to get the timing right, as measures that impose further – or the wrong type of – restrictions on lending could inadvertently damage prospects for economic recovery. 

If changes are to be made, the FSA may want to consider introducing a transitional period to help avoid unintended consequences that could disrupt the economy further and impose reduced choices and increased hardship on consumers. A similar approach is being taken in relation to its new stance on liquidity.

The risk of unintended, harmful consequences is magnified because of the scope and scale of regulatory intervention being considered by the FSA. As well as changes to the mortgage rulebook and the debate about capping and restricting higher-risk products, the FSA is also considering measures that could affect the amount and type of lending by different types of lender. 

The regulator has, for example, already launched a consultation on a specialist sourcebook for building societies. It is considering categorising societies into three types – traditional, limited and mitigated.

We accept the case for a differentiated approach based on differences between firms in their ability to manage risk – whether large or small, or operating in mainstream or niche markets. But we believe it is wrong in principle to change the operating rules for building societies before proper consideration on the wider issues affecting all lenders, borrowers and the market as a whole.

Restricting different types of lender before completing the more comprehensive mortgage market review is unlikely to enhance the vibrancy and competitiveness of the market, to the overall detriment of consumers.

Conclusion

While consulting with members on how mortgage regulation should be modified, we have maintained a useful dialogue with the FSA. Throughout the process, we have been impressed by the thoroughness of the FSA’s staff in approaching its task.

We believe, however, that it is crucial to remember that the current problems associated with the mortgage market stem not from a failure of the mortgage conduct of business rules – or from widespread credit problems – but essentially from a shortage of funding.

The market has already adjusted to the funding shortage in ways that address many former concerns. The process of correction has made all firms less disposed to risk.  But it has also left us with a mortgage market that cannot deliver adequate choices for all consumers.

Many of the products and practices around which debate has revolved have already been withdrawn or modified. Banning products or imposing regulatory limits is not necessary to address problems that have already resolved themselves – and if we are to have enhanced supervision in future that will successfully identify potential problems before they become real ones, in a way that did not happen in the past.

In addressing consumer detriment, the FSA should have in mind a wider goal of promoting a vibrant and competitive mortgage market, encompassing different business models, catering for a wide range of customers, and having the ability to innovate and adapt to changing circumstances.

That sort of market cannot be delivered by favouring one business model over another, by putting in place unnecessary controls and restrictions on firms or by regulating the market in a way that deters new firms from entering it.

The FSA faces a wide range of challenges and potential pitfalls in completing its review. Perhaps the biggest of all would be to take the review forward at a time when the mortgage market displays few of the characteristics that the FSA should be seeking to promote through regulatory intervention. 

Against the backdrop of a malfunctioning mortgage market – but one that remains fundamentally risk-averse – there is no need for urgent intervention by the FSA to complete its review, change the mortgage rulebook or implement broader regulatory change.