09/10/2014 Macroprudential Regulation of the UK Residential Mortgage Market: The What, the How and the Why OeNB Workshop, Vienna Fergus Cumming, Monetary Assessment and Strategy Division October 2014 Disclaimer The views expressed in this presentation do not necessarily represent the views of the FPC, the MPC or the Bank of England. Please contact fergus@bankofengland.co.uk for any queries. 1
09/10/2014 Outline • Who are the Financial Policy Committee? What is their mandate? • UK housing narrative and policy motivation • Modelling approach • The June 2014 Financial Stability Report Policy recommendations • Questions and discussion The Financial Policy Committee 2
09/10/2014 Financial Policy Committee DG-PR DG-MP DG-FS Governor (Chair) FSSR - ED Andrew Bailey Charlie Bean Jon Cunliffe Mark Carney Spencer Dale CEO-FCA HMT(non-voting) Martin Wheatley Charles Roxburgh External External External External Clara Furse Don Kohn Richard Sharp Martin Taylor As of June 2014 FPC mandate • Primary objective – The FPC is mandated to reduce systemic financial stability risks, including unsustainable levels of leverage, debt or credit growth . • Secondary objective – Subject to this, support the Government’s economic policy: • ‘strong, sustainable and balanced growth that is more evenly shared across the country and between industries’ • ‘unsustainable levels of private sector debt and rising public sector debt’ 3
09/10/2014 UK housing narrative and policy motivation House price inflation has increased in all areas of the United Kingdom during the past year Annual house price inflation 4
09/10/2014 Potential risks from the housing market • Credit risk on secured lending – But mortgage lending historically profitable – Focus of microprudential supervision • Household debt and economic volatility • Link between credit booms and financial crisis Household debt and economic volatility UK mortgagors’ non-housing Adjusted consumption growth over 2007–12 consumption as a share of income by debt to income ratio group 5
09/10/2014 Credit booms and financial crisis • No simple relation between average debt level and crisis • Rapid growth in private debt is a strong predictor of financial crisis • Given the estimated costs of financial crisis, reducing the probability of crisis may save the tax payer a large amount of money New mortgage lending at high LTV ratios has risen modestly New mortgages advanced for house purchase by LTV 6
09/10/2014 Modelling approach Modelling a central scenario • Use loan-level information available on current borrowers • Put into future nominal terms using macro forecasts for house prices and incomes • Calculate unconstrained LTV and LTI for each future borrower… but rule out extremes – Assume borrower willing to accept property worth 10% less – Assume a 95% LTV and 5.5x LTI limit 7
09/10/2014 Illustrative impact of LTI flow limit on distribution of mortgages advanced in year 3 of the central scenario (a)(b) Share of mortgages Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) 0 1 2 3 4 5 LTI Sources: FCA Product Sales Data and Bank calculations. a) See footnotes for Chart 5.12 . b) Height of lines indicate frequency of population at given LTI. Area under each curve sums to 100%. Modelling an upside scenario Gross lending by LTI under two alternative Motivating an upside scenario scenarios 8
09/10/2014 Illustrative impact of LTI flow limit on distribution of mortgages advanced in year 3 of the central and upside scenarios (a)(b) Share of mortgages Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) 0 1 2 3 4 5 LTI Sources: FCA Product Sales Data and Bank calculations. a) See footnotes for Chart 5.12 . b) Height of lines indicate frequency of population at given LTI. Area under each curve sums to 100%. The June 2014 Financial Stability Report policy recommendations 9
09/10/2014 Two recommendations Recommendation 1 – Stricter affordability criteria “ …lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage points higher than the prevailing rate at origination . This recommendation is intended to be read together with the FCA requirements around considering the effect of future interest rate rises as set out in MCOB 11.6.18(2). ” Recommendation 2 – Limit the flow or high LTI mortgage lending “ …ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income ratios at or greater than 4.5 . This recommendation applies to all lenders which extend residential mortgage lending in excess of £100 million per annum. ” A ‘package’ approach Affordability test Share of mortgages • This acts as a (soft) cap on the LTI’s that can be extended Outturn (2013Q2- 2014Q1) Portfolio limit • Do not cut out credit unnecessarily 0 1 2 3 4 5 LTI 10
09/10/2014 Insurance policy • Indebtedness is not an immediate threat – but guard against tail-risk • House prices to earnings expected to rise (structural reasons) • Take graduated steps – avoids more action later on Illustrative impact of LTI flow limit on distribution of mortgages advanced in year 3 of the central and upside scenarios (a)(b) Share of mortgages Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) 0 1 2 3 4 5 LTI Sources: FCA Product Sales Data and Bank calculations. a) See footnotes for Chart 5.12 . b) Height of lines indicate frequency of population at given LTI. Area under each curve sums to 100%. 11
09/10/2014 FPC recommendation as an insurance policy Summary • The What – FPC remit and focus on indebtedness • The Why – Indebtedness has increased rapidly in preceding months – Excess indebtedness can cause macroeconomic feedbacks that threaten financial stability – Model future distributions of borrowers including under adverse (house price) scenario � looks worrying • The How – Create a policy package that curtails bad outcomes if this scenario arose – Work closely with bank supervisors to implement policy in fair and efficient way 12
09/10/2014 Questions and discussion 13
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