CML news & views

On the day the Financial Services Authority published its recent consultation paper on responsible lending, the FSA chairman, Lord Turner, delivered a speech outlining the regulator’s vision of the proposed scope of mortgage regulation. The FSA was, he said, now signalling a move away from a dynamic and competitive mortgage market with maximum freedom of choice and readily available credit – a market, he acknowledged, “with which most of society seemed happy.”

Instead, the FSA aspires to create a market that is sustainable for all participants and is a flexible market that works better for consumers. However, it will be a market with fewer participants, less competition and less choice at a higher price for consumers, as well as being intensively regulated at higher cost. 

On a cursory review of the cumulative impact of the proposals in the FSA consultation paper, we do not believe the FSA will achieve its desired outcomes. And it risks serious unintended side effects which will be damaging to consumers’ housing choices and to the economy more generally. 

The extent to which there should be regulatory reform of the mortgage market was not, Adair Turner accepted, “a purely technical issue which can be left to technicians.” Instead it was “a social and political choice which should merit extensive debate.”  We agree, and we believe some wrong regulatory choices have been made. 

In his speech on the day the FSA published its paper, Lord Turner accepted that what the regulator was proposing amounted to “a major shift in our willingness to intervene in the free market relationships through which borrowers and lenders would otherwise make their own free choices about appropriateness, risk and return.”

Lord Turner continued:

“This is a major shift in philosophy and I believe a necessary one. But also one which carries risks – the risk that we swing to the other extreme, restricting consumer choice where we do not need to, and imposing regulatory costs which are disproportionate to what we can realistically achieve. We need to strike a balance, and to get that balance right, we need to debate it openly and explicitly: with the industry, with the press, with the politicians, with society.”

Consumer impacts

We believe that most consumers have not yet fully understood the impact of the FSA’s proposed regulatory reform on their future housing choices as existing borrowers (with fewer or no mortgages if they were previously self certification borrowers – the term “mortgage prisoner” has been coined for this group) or as prospective home owners (their aspirations will be blocked by the new regulatory approach – effectively excluded from the home owner market for the long term). We also believe that insufficient regard has been given by politicians to the form of regulatory reform which the FSA proposes and its likely market impact. We therefore need a debate on what housing choices for consumers should be available in the future, the role of housing finance in delivering a choice of tenure to consumers whether as a home owner, private renter or through funding of social housing, and the proportionate approach to regulation to ensure responsible lending and to deter irresponsible borrowing. 

Put simply, if prospective borrowers will not be able to become home owners in the future, where will they live?

The government’s aspirations

On the face of it, the regulatory outcome favoured by the FSA – a smaller and risk averse mortgage market - is in conflict not just with a balanced view of the housing and financial interests of consumers but with what the new government wants to deliver on home-ownership. The new housing minister, Grant Shapps, has already spoken of his desire to promote an “age of aspiration,” with home-ownership at its heart.

In the aftermath of the credit crunch, the Survey of English Housing has reported the first significant decline in owner-occupation for many decades. Between 2003 and 2008, home-ownership declined from 70.9% to 68.3% of the population. It is difficult to see how this trend could be reversed – and how we can help deliver an age of aspiration – if regulatory reform reinforces a lack of competition in the mortgage market, with a shortage of funding exaggerating regulatory impacts.

We do, of course, accept that there is a clear case for regulatory reform in the aftermath of the financial crisis and past irresponsible lending which happened for the reasons spelt out by the FSA in its paper. In particular, we acknowledge the strong arguments behind the government’s proposals for enhanced macroprudential regulation of capital and liquidity rules. By the same token, and the argument remains valid, the impact of conduct rules on top of prudential changes is likely to worsen the unintended consequences of intervention on the market structure. The FSA should not rush in with new conduct rules when the market risks that it identified do not exist now as in 2006/2007 and the impact of other tighter prudential controls is still to be fully felt.   

We favour reinforced consumer protection but not abdication of consumer responsibility. It is important to get the balance right as it remains in borrowers hands to ensure they do not over extend their use of credit, not the lenders to take a view on ongoing affordability throughout the 25 year term of the mortgage as the draft rules suggest. Excessive consumer protection – particularly in the current risk-averse lending environment – will lead lenders to step back from perfectly sensible lending markets, such as interest only mortgages. With the lending market likely to undershoot the CML’s forecast of £150 billion by some margin in 2010, the FSA’s proposed actions will shrink the market still further. And yet many in the mortgage market would say that affordable mortgage credit by borrowers taking sensible borrowing and personal decisions on their choice of housing would underpin a “normal” mortgage market of nearer £250 billion annually – well below the £363 billion in 2007 but substantially above today’s levels of housing transactions.  

The FSA’s approach to consultation

We agree with the FSA’s view that there should be a debate about the future of regulation. We have been engaged in it with members, the FSA and other interested parties for some time. The debate should be widened into the public domain to ensure that the type of mortgage market that people want really will be delivered by this set of proposals, and that views are fed back to the FSA by its November deadline.

It is crucial that what emerges from consultation on key issues for consumers, like the balance of interests in verifying income and assessing affordability, is not pre-determined by any existing FSA perspective on the desired regulatory outcomes rather than the political, social and economic outcomes. Essentially, there will always be a trade-off between protecting consumers from over-borrowing and removing barriers to home-ownership.

We look forward to working with the FSA to ensure that a pragmatic approach to implementation can be adopted as far as possible, to reduce the negative side-effects that may arise from well-intentioned regulation.

The main concern at this stage is not risky lending but whether consumers have access to sufficient finance. The main risk of implementing regulatory reform in the short term is that the gain does not match the pain. Firms and consumers will pay the costs of introducing new regulatory requirements now, in a market in which they are not needed, and with any potential benefits for borrowers only delivered at some uncertain time in the future.

Conclusion

On behalf of lenders, we will contribute to the debate the FSA wants to promote. We agree that it should take place, and that it should be as comprehensive and inclusive as Lord Turner suggests.

We also believe there are tangible and significant risks to the market associated with the FSA’s current approach. In our view, there is already a clear danger that the regulator’s current proposals will restrict consumer choice unnecessarily, and impose disproportionate and unjustified costs on firms and borrowers. However, the FSA believes these are structural impacts and new costs worth bearing – but once the implications are better understood, will this be consumers’ view?