UK lenders back international financial stability proposals
Published: 2 May 2012 | Author: Bernard Clarke
Following a period of consultation during which we represented the views of UK lenders, the Financial Stability Board (FSB) has now finalised the principles it believes will uphold sound residential mortgage underwriting standards in the world’s major economies. We believe the FSB’s principles should create a sensible framework for good practice among its members – primarily G20 countries, including the UK.
The Board began consulting in 2010 on the principles, which it believes will address the dangers that played such a major role in the financial crisis: poor residential underwriting practices spreading infection from individual countries into the global system. The principles, published by the FSB in April, provide a framework for minimum acceptable standards to limit the risks that mortgage markets pose to financial stability, and to safeguard investors and borrowers.
The aim is to help strengthen mortgage underwriting practices and to establish standards against which supervisors can monitor developments more effectively and detect any erosion of quality in lending decisions, particularly when housing markets are booming. The principles will apply to all mortgage lending, including the buy-to-let sector. They seek to uphold:
- effective verification of income and other financial information upon which lending decisions are based;
- lending based on "reasonable debt coverage," taking into account borrowers’ credit commitments and non-discretionary spending, with adequate stress-testing for increases in interest rates;
- lending based on appropriate loan-to-value ratios, with measures to stop underwriting standards being eroded in buoyant conditions (but without necessarily setting inflexible and inappropriate loan-to-value caps);
- effective management of collateral, with measures to reinforce robust valuation;
- prudent and appropriate use of mortgage insurance; and
- a framework for implementing the safeguards, ensuring there is effective regulation and supervision of what lenders do, with appropriate tools and powers.
The principles are intended to improve the credit quality of mortgages, and do not set out to provide protection directly for consumers. Instead, the FSB recommends that member states develop their own consumer protection measures. But the principles overlap the provisions emerging from the mortgage market review being overseen by the Financial Services Authority in the UK and the directive on credit agreements relating to residential property being developed in Europe.
At a high level, all three initiatives are aligned. Each, for example, will require income and expenditure to be assessed and affordability to be "stress-tested" against a rise in interest rates. Although there are differences in detail, with the FSB preferring a more prescriptive approach in some areas, this is unlikely to create significant issues for the UK as the principles provide flexibility for member states.
The FSB does not have legislative powers to uphold its principles but operates instead under a "comply or explain" principle. That gives member states flexibility to demonstrate how their domestic regulation achieves the same outcomes that the principles are seeking to deliver.
To monitor the effectiveness of its principles, the FSB will undertake peer reviews of member states. It will scrutinise the regulatory and supervisory regimes in selected countries to see if they are compliant. The FSB will publish the outcome of these reviews, including any changes it recommends. It intends to begin the review process once member states have had an adequate period to implement the principles.