Lenders urge use of right tools - and right timing - for intervention
Published: 5 December 2013 | Author: Bernard Clarke
In its Financial Stability Report published last week, the Bank of England gave a comprehensive and wide-ranging assessment of potential threats arising from housing and mortgage markets, and the measures it could deploy to counter them. The Bank also announced its first move to withdraw stimulus from the housing market since the onset of the financial crisis in 2007.
Lenders welcome publication by the Bank of its analysis of what it sees as risks that may emerge from the market. Details given by the Bank of the range of tools at its disposal to address potential problems, and indications of the order in which it might use them, were also helpful to lenders.
In our initial response to the Bank’s announcement of an adjustment to the Funding for Lending scheme (FLS) and other measures, we said that they were "a surprise, but not a shock." Lenders are well-equipped to meet funding needs, as conditions in wholesale markets have improved and retail deposits are robust.
As originally planned, we will therefore next week publish our own forecasts for housing and mortgage markets in 2014 and 2015.
A signal to the market
Given that the Bank saw an opportunity to send a signal to the market, lenders will be re-assured that it chose to do so with what some commentators view as a relatively modest and timely intervention. Firms can continue to draw funds under the FLS to support mortgage lending until the end of the year, and these funds will still be available to fund activity thereafter.
The Bank’s intervention will therefore not cause short-term disruption to the market, although it may lead to a modest tightening of credit conditions over time.
We agree with the fundamental assessment by the Bank that activity in the housing market remains below long-term trends, and that there is little evidence of any immediate threat to stability. The Bank goes on to say, however, that risks may grow if stronger activity in the market is accompanied by further substantial and rapid increases in house prices, and a further build-up in levels of household indebtedness, particularly as some households already have high levels of debt.
The Bank’s toolkit
The Financial Stability Report outlined an extensive range of tools available to the Bank to curb activity in the housing market. Some measures, including requirements for lenders to hold more capital, are already in place. However, the Bank also used the Report to outline a second series of measures that it wants to apply now, including restricted access to the FLS to support household lending from next year. Finally, it gave details of a third, much more extensive group of "potential future tools" that it could use in response to bigger risks emerging from the housing market.
The first group of "actions already in train" include:
- the implementation of recommendations made earlier this year by the Bank’s financial policy committee to raise banks’ capital and introduce other international capital reforms;
- stress-testing by the Bank of the UK’s banking system, including assessing the resilience of financial institutions to stress emerging from the housing market; and
- the implementation next spring of measures as a result of the mortgage market review, which will reinforce more robust assessment of affordability for individual borrowers, and requirements to stress-test loans against higher interest rates.
Additionally, the Bank announced three measures in the Report that it wants to implement now. Aside from the removal of support for household lending through the FLS, the other measures were:
- the withdrawal of temporary capital relief on new household lending qualifying for the FLS from the beginning of next year; and
- a recommendation that lenders should be required by the Financial Conduct Authority (FCA) to reflect any proposals by the Bank’s financial policy committee for more rigorous stress-testing of lending against higher interest rates.
Finally, the Report gave details of five further tools that could be used to address greater risks emerging from the housing market:
- recommendations to the FCA or the Prudential Regulation Authority (PRA) on tighter underwriting standards;
- recommendations to the Treasury on measures to reduce the stimulus provided by the Help to Buy scheme;
- recommendations or directions to the PRA to tighten capital requirements for mortgage lending;
- raising the counter-cyclical capital buffer; and
- recommendations on the maximum loan-to-value, loan-to-income or debt-to-income ratios or restrictions on the length of mortgage term.
While the Report is silent on how the use of these tools may be prioritised, applying them in this order would also help fulfil the Bank’s objective, stated in the Report, of implementing "a proportionate and graduated response" to risks that may emerge in the housing market.
The views of lenders
Most lenders have already anticipated the new rules next April as part of the mortgage market review and have been applying reinforced underwriting standards to new business for some time.
Lenders also recognise, and support, the Bank’s use of tools to target the emergence of risks from the housing market. In practice, the outcome will depend on how and when the tools are applied.
While the priority is to take effective action, there is much that can be done in selecting the right tools – and the right timing – to mitigate the potentially harmful effects of intervention. Lenders will therefore be particularly encouraged by the Bank’s emphasis on delivering a “proportionate and graduated” response.
There is also much that the Bank can achieve in how it chooses to communicate to the market the rationale for intervention.
Lenders are broadly re-assured that, given the Bank’s desire to send a signal to the market, and the extensive range of tools at its disposal, it should at this stage choose a measure like the withdrawal of access to the FLS. This measure looks like a proportionate response because:
- An adequate supply of mortgage funding is now less dependent on support from the FLS. Most mortgage lending is funded by retail deposits, which remain strong. Wholesale funding markets are now also operating more effectively than when the FLS was first introduced, and provide an adequate alternative source of funding for some lenders.
The latest data, published by the Bank earlier this week, showed an increase in drawings under the FLS, which totalled £5.5 billion in the third quarter of 2013, compared to £1.1 billion in the preceding three months. These totals are, however, skewed by larger drawings under the scheme in recent months by a small number of lenders.
- If the withdrawal of access to the FLS puts some modest upward pressure on mortgage pricing, as some commentators have predicted, the effects are unlikely to deliver “shocks” to consumers. Firms are still able to draw on the scheme until the end of this year, and the FLS has already contributed to a significant fall in new lending rates, which are now around 80 basis points lower than in the summer of 2012, as Chart One shows. The prospect of a small increase in mortgage pricing over time would only partially reverse the benefits of lower borrowing costs.
Chart One: Average mortgage interest rate on new business
Source: Bank of England
Another possibility is that the Bank’s intervention may bolster investor confidence in the long-term stability of UK housing assets. If so, investors may be attracted to the sector, potentially helping to offset some of the effects of more restricted access to the FLS.
- Another merit of the decision to intervene in this way is that, even if an adjustment in access to the FLS exerts upward pressure on mortgage pricing, the effects are likely to emerge over time. The impact on borrowers will be felt only after the initial effects have been absorbed by lenders. So, the use of this sort of proportionate and graduated intervention is unlikely to have de-stabilising or unpredictable consequences.
- Finally, the Bank has given a clear signal to the market that it will intervene if it sees the need to address increasing risks, but will consider the right tool from the many at its disposal. Firms and consumers will benefit in the long run from greater stability if the Bank opts for the right kind of regulatory intervention.
One of the clear benefits of proportionate and timely intervention is that the Bank may avoid the need for much more intrusive, and potentially disruptive, action later on. The Bank’s toolkit is wide-ranging, and lenders and borrowers would prefer modest, early intervention to the use of much blunter and less well-targeted tools in the future.