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WorldJuly 29 2013

Mixed messages for UK mortgage market

The UK Treasury is trying to help lenders step up mortgage financing, but new regulatory agencies are focused on controlling systemic risk.
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What’s happening?

In March 2013, UK chancellor of the exchequer George Osborne introduced a 'Help to Buy' scheme for first-time homebuyers, with the government offering to guarantee the first 20% of a new mortgage. In April 2013, the former Financial Services Authority (FSA) was split into the Prudential Regulatory Authority (PRA) – which became part of the Bank of England – and the Financial Conduct Authority (FCA). One of the FCA’s first acts was to urge banks to address potential asset quality problems stemming from interest-only mortgages, as borrowers might not be able to afford repayments if interest rates begin to rise from current historic lows.

In June, the Parliamentary Commission on Banking Standards proposed raising the 3% leverage ratio enshrined in the international Basel III agreement on capital regulation to 4% for UK banks. A month later, the PRA proposed bringing forward the date of compliance with the 3% ratio, which had been scheduled for 2019, to 2014. It also narrowed the definition of Tier 1 capital to common equity Tier 1.

Who’s in charge?

This is the question that is perplexing banks and building societies. The Treasury is clearly seeking to make home ownership more affordable and stimulate the economy, but the PRA is unwilling to downplay its financial stability remit.

“Within the totality of the various authorities and government, there are objectives that in themselves are perfectly laudable, but which are obviously in conflict, and there seems to be a disagreement about the balance between the two,” says Jeremy Palmer, head of financial policy at the Building Societies Association (BSA).

The question of tackling legacy interest-only mortgages is another area where new regulatory responsibilities intersect. Treatment of customers is an FCA domain, but the assessment of asset quality would fall to the PRA. Both agencies and the Treasury are represented in the new Financial Policy Committee (FPC) under the auspices of the Bank of England.

“It is healthy to have strong independent regulators, as politicians may sometimes find it difficult to reconcile different objectives. The new regulatory regime means problems are looked at through two separate lenses, but the two pairs of eyes need to be able to work together. It is easier at the moment, as both authorities are largely built from ex-FSA staff, but the FPC must be used to ensure that those relationships are maintained,” says Graeme Ashley-Fenn, head of the UK regulatory advisory practice at consultancy Alvarez & Marsal, who was the director of authorisations at the FSA until the end of 2011.

Mr Ashley-Fenn adds that regulated institutions are still adjusting to the new structure and the differences between the PRA and FCA. Both agencies assign staff to monitor each financial institution, but the FCA also sends in additional staff to address specific topics as they arise, leaving regulated institutions with some uncertainty about their points of contact within the FCA.

What to the lenders say?

REG RAGE - confusion

Mortgage lenders have welcomed the FCA’s proposals that interest-only borrowers should be contacted early to discuss alternative terms to make their mortgages more affordable. Mr Palmer says the organisation deserves credit for avoiding extreme statements and leaving the door open to interest-only products in the future.

“Generally, our members are already communicating with their borrowers to propose extended maturities or other forms of secured lending. The FCA has shown a new approach in identifying a potential issue to try to avoid it becoming a major problem, but without talking up the scale of the difficulties,” he says.

However, the leverage ratio proposals are causing more alarm. The UK appears to be deviating from the EU’s capital requirements regulation (CRR), both by bringing forward the deadline for the leverage ratio, and by narrowing the capital stock that is eligible.

“CRR calls for further study of the 3% leverage ratio, and explicitly suggests banded requirements to recognise the value of low-risk business models such as mortgage lending compared with, for example, unsecured consumer lending. The transition period was also carefully calibrated to reach the end-point of higher capital ratios without causing a sharp deleveraging, so it would make sense for the PRA to keep to that approach,” says Mr Palmer.

What’s the outcome?

Total mortgage balances fell fractionally in the first five months of 2013, with a rise of £4bn ($6.14bn) in net new lending by building societies offset by a fall of £4.2bn in mortgages extended by banks and specialist lenders. Building societies have fewer options for raising capital than listed banks, so an increased or accelerated leverage ratio might have a greater impact on their lending.

The FCA report estimates that 90% of interest-only borrowers already have a mortgage repayment plan in place, limiting potential risks. However, it remains to be seen if the Treasury emphasis on new homeowners will ultimately affect asset quality. Over the first five months of 2013, the BSA reported that loans to first time buyers with a deposit of less than 10% rose 2.5 times. 

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Read more about:  Reg rage , Regulations , Western Europe , UK