From 1st July the Council of Mortgage Lenders is integrated into a new trade association, UK Finance. For the time being, all UKF mortgage information will continue to be published on this website, and UKF member-only mortgage information will only be available here.

UK Finance represents around 300 firms in the UK providing credit, banking, markets and payment-related services. The new organisation takes on most of the activities previously carried out by the Asset Based Finance Association, the British Bankers’ Association, the Council of Mortgage Lenders, Financial Fraud Action UK, Payments UK and the UK Cards Association. Please go to www.ukfinance.org.uk for wider content and updates from UK Finance.

Last updated: 28 February 2017

At a glance

  • The funding of lenders consists of two important elements: liquidity to provide loans (mortgages, personal loans etc.) and capital to absorb losses.
  • It is important for lenders to have the widest access to both liquidity and capital. Capital is generated by retained earnings or from external investors. Larger banks and some building societies have access to a wider variety of capital (equity in the case of banks, in addition to loss absorbing securities, sold to either retail or institutional investors) than smaller lenders.
  • Regulators proscribe the minimum amount of capital lenders need. This is calculated by using by using a risk-based system, referred to as the “Basel approach” (see below). In addition, regulators have introduced a non-risk based evaluation of the capital requirements. In the UK this has manifested itself in the introduction of a leverage ratio.
  • The framework for UK capital regulation is contained within two EU legislative instruments: the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR). Collectively these are known as CRD IV.
  • This framework broadly implements the international regulatory framework developed by the Basel Committee on Banking Supervision (Basel) with some additions, for example, a systemic capital buffer and a global systemic institutional buffer (G-SIB).
  • Since 1988, Basel have introduced a number of international frameworks, the latest iteration is Basel III. The Basel system of risk based capital calculations becomes part of the UK regulatory framework either by the UK regulatory authorities adopting the proposals or the EU enacting its own regulatory legislation based on the Basel methodology. 
  • The Basel/EU frameworks encapsulate three pillars:
    • Pillar one details the minimum level of capital a lender needs to hold. This focuses on the credit risk of different assets and a risk weight for assets.
    • Pillar two focuses on the supervisory review of the level of capital and factors in other risks lenders have for which capital needs to be held e.g. systemic risk, but also reputational, pensions etc.
    • Pillar three concerns disclosure and transparency where market discipline modifies lenders behaviour and the level of capital held.
  • Under Pillar one, lenders calculate the minimum level of capital needed by assigning a risk weight to a particular asset. Under the Standardised Approach, the appropriate risk weight is proscribed.  For mortgages, with a Loan-to-Value (LTV) below 80% the risk weight under the Standardised Approach is 35%. Lending above 80% LTV attracts a higher risk weight (75%) for that portion of the mortgage above 80% LTV. 
  • Lenders can, however, also use the Foundation and/or the Advanced Internal Ratings Based Approaches (F-IRB or A-IRB), where the risk weight used by lenders is partially derived from the historic performance of different assets which generate a Probability of Loss (PL) and a Loss given Default (LGD), but includes other variables. Lenders using the more complex IRB approaches have developed sophisticated risk management models which calculate the risk weight for a portfolio of assets. 
  • Following the financial crisis there were criticisms of the risk-based system.  Regulators reacted to this by imposing additional capital requirements within the risk-based framework e.g. the UK regulator now has the potential to imposed sectorial capital requirements on lenders if they identify an increase in risk with a particular type of lending.  The UK regulator has not, as yet, imposed any sectorial capital requirements.

CML position

We support the strengthening of the regulatory architecture of the UK financial system in so far as it creates a more robust and stable system. We do have concerns, however, that the fast pace of regulatory change and the introduction of new regulation makes the capital calculation increasingly complex for lenders – we therefore urge regulators to allow time for new capital regulations to “bed in”; and to evaluate the effectiveness of the changes before introducing further new regulation.

We favour the risk based capital calculation over the other less sophisticated approaches, for example the use of a leverage ratio, where we have identified that it potentially favours certain business models. We make no comment over the appropriate calibration level for a leverage ratio, but are keen to ensure a level playing field between different business models.

Why this is important for lenders 

Following the financial crisis, various countries including the UK, introduced additional regulatory oversight of the financial system as a whole. One of the factors identified as contributing to the crisis was the amount of capital held by lenders but also the quality of capital, i.e. the ability of capital to absorb losses. 

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