The Bank of England’s Financial Policy Committee (FPC) met on 17 and 25 June 2014. Whilst recognising the improvement in global banking system resilience due to higher levels of bank regulatory capital (including in the case of UK banks as a result of steps taken in response to the capital recommendations it made in March 2013), the FPC noted that financial stability risks remained, including those stemming from the housing market. The minutes record the discussions of the FPC which led to the making of the following recommendations:
- When assessing affordability, mortgage 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).
- The PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income (LTI) 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. The recommendation should be implemented as soon as is practicable.
The FPC also set the countercyclical capital buffer rate for UK exposures at 0%.
The PRA has said that it will work together withe the FCA to ensure that their respective implementation proposals are complementary and coordinated.
The PRA has published a consultation paper on proposals for implementing the FPC’s recommendation on loan to income ratios. The consultation is open for comments until 31 August 2014, and final rules will come into effect on 1 October 2014.
The PRA’s rules are not designed to capture all micro-prudential aspects of credit risk associated with the individual borrower or the other factors that a lender might take into account when making a lending decision. Lenders should continue to apply whatever criteria they feel are appropriate and commensurate with their risk appetite when taking individual lending decisions. The PRA would not expect firms to vary their lending practices as a result of this policy unless they find that they would otherwise be in breach of the limit.
The limit will apply to the number of mortgages completed. While rules will not come into force until 1 October 2014, mortgage offers made or decisions in principle taken before the proposed rule comes into effect but which complete after 1 October 2014 will count towards the limit. The PRA will apply a minimum threshold which will mean that the limit will not apply to firms which report less than £100m of new mortgage lending annually. This will be assessed on a rolling basis.
Firms that predominantly underwrite very high-LTI lending and for whom the LTI flow limit is binding may have to revise their business strategies to comply with the rule.
The FCA said in response that:
- it will consult on general guidance to provide details on how it proposes to follow the recommendation on loan to income ratios. This guidance would cover how the de minimis £100 million threshold and the ratios would be calculated and applied. Since only a small number of FCA regulated firms could be affected, the FCA considered that general guidance would be a proportionate and appropriate approach to implementing the loan to income ratio, particularly while the industry is continuing to adjust to the Mortgage Market Review.
- its mortgage rules already require firms to have regard to FPC recommendations on stress test levels.