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09/10/2014 1

OeNB Workshop, Vienna

Macroprudential Regulation of the UK Residential Mortgage Market: The What, the How and the Why

October 2014

Fergus Cumming, Monetary Assessment and Strategy Division 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.

Disclaimer

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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

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Financial Policy Committee

DG-MP Charlie Bean DG-PR Andrew Bailey CEO-FCA Martin Wheatley External Clara Furse External Richard Sharp External Don Kohn External Martin Taylor HMT(non-voting) Charles Roxburgh Governor (Chair) Mark Carney DG-FS Jon Cunliffe FSSR - ED Spencer Dale

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’

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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

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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

UK mortgagors’ non-housing consumption as a share of income by debt to income ratio group Adjusted consumption growth over 2007–12

Household debt and economic volatility

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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

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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

09/10/2014 8 Illustrative impact of LTI flow limit on distribution of mortgages advanced in year 3 of the central scenario(a)(b)

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%.

1 2 3 4 5 Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) Share of mortgages LTI

Gross lending by LTI under two alternative scenarios

Modelling an upside scenario

Motivating an upside scenario

09/10/2014 9 Illustrative impact of LTI flow limit on distribution of mortgages advanced in year 3 of the central and upside scenarios(a)(b)

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%.

1 2 3 4 5 Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) Share of mortgages LTI

The June 2014 Financial Stability Report policy recommendations

09/10/2014 10 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

• rigination. 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

• f £100 million per annum.”

Two recommendations A ‘package’ approach

Affordability test

• This acts as a (soft) cap on the

LTI’s that can be extended

Portfolio limit

• Do not cut out credit

unnecessarily

1 2 3 4 5 Outturn (2013Q2- 2014Q1) Share of mortgages LTI

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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)

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%.

1 2 3 4 5 Outturn (2013Q2-2014Q1) Central scenario (year 3, with and without limit) Upside scenario (year 3, without limit) Upside scenario (year 3, with limit) Share of mortgages LTI

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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

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Questions and discussion