European proposals for the banking and mortgage sector are likely to have a major impact on the UK’s mortgage regime. The Mortgage Credit Directive is designed to harmonise the mortgage regimes across the EU, so that in theory at least compliant organisations could operate in any member state.
However, the end of March saw the closure of the consultation period for two papers from the Bank of International Settlements’ (BIS’s) Basel Committee on Banking Supervision (BCBS) that have significant implications for the mortgage market. While many of the issues are highly technical and concern the regulation and risk management of the banking sector, as they currently stand they are likely to have a great impact on UK mortgage lenders and ultimately borrowers.
The BIS’s Basel regime revolves around the solvency and capital adequacy of financial institutions. It is being implemented across the EU and beyond and requires participating nations to adopt its approach to capital adequacy.
Basel I had a basic approach to the calculation of capital requirements and was enhanced by Basel II, introduced in 2008. Basel III is designed to further improve and fine-tune those calculations but threatens to increase the amount of capital that financial institutions are required to hold against certain types of assets, effectively increasing the cost of lending.
Capital floors
One paper was about revising the way that lenders calculate the amount of capital they are required to hold and allocate specific risk weightings to different kinds of assets. The other concerned revision of the capital floor – which is designed to ensure that a bank’s capital does not fall below a certain percentage of its capital requirements.
There were around 130 responses to the papers, including from both the Building Societies Association (BSA) and the CML, which set out their objections and particularly the likely effect on the UK mortgage market.
The BSA points to an assertion by the European Association of Co-operative Banks, of which it is a member, that the introduction of capital floors “could exacerbate competitive distortions, seriously damaging the mortgage finance market in Europe compared with (in particular) the US”.
The CML explains that the proposals will affect residential mortgages, buy-to-let lending and lending to housing associations in particular. A summary of the effects it predicts appears in the Box inset. At present, lenders apply a 35 per cent risk weighting to lower LTV mortgages but under the new proposals, the risk weighting would be based on both the LTV and the borrower’s debt service coverage (DSC) ratio, a calculation that compares the borrower’s income against the amount required to cover the mortgage debt.
As a result, borrowers with a low LTV (40 per cent or less) and a low DSC ratio (35 per cent or less) could potentially have a risk weighting as low as 25 per cent applied. However, higher LTV borrowers with higher DSC ratios could have a weighting of up to 100 per cent.
Such changes would lead to higher borrowing costs and lenders might simply decide to pull out of those sectors altogether
Encouraging churn
Another objection the CML has is that the weighting would be determined at the start of the loan and remain the same despite the way that the risk profile of a mortgage can change throughout its term. As house prices rise, for example, the LTV can fall, potentially reducing the risk. The CML argues that lenders should be able to adjust the risk weighting based on the property value during the lifetime of a loan, otherwise they will be incentivised to encourage borrowers to remortgage in order to lower their risk weighting as prices rise and LTVs effectively fall.
The proposals, it says, will make first-time buyer loans much more scarce and more expensive. Also, buy-to-let lending would be categorised as specialist lending, immediately raising its risk rating from 35 per cent to perhaps as much as 120 per cent. The same fate could befall lending to social housing providers. The CML points to the low levels of default in both types of lending in the UK. Again, such changes would lead to higher borrowing costs and lenders might simply decide to pull out of those sectors altogether.
The recent implementation of the MMR means that the UK market has to wait for some of these reforms to settle in before it makes any more changes, the CML argues. While the BIS is scheduled to publish its final standards by the end of 2015, the CML says that it hopes that the weight of opposition will mean that it reconsiders its proposals and conducts further consultation.
The impact of the proposals according to the CML |
• If implemented, the proposals could lead to a significant increase in the amount of capital held against some residential property lending, including to most first-time buyers, buy-to-let lending and the commercial funding of housing associations. • Mortgages in the markets affected would become scarcer and more expensive if the proposals are implemented. • The costs imposed on both buy-to-let lending and funding for housing associations could lead some firms to withdraw from these markets altogether, reducing choice and further disadvantaging consumers. • For most lending, the proposed risk weightings are unnecessarily severe. Both buy-to-let and funding for housing associations, for example, have a good record, with low risk. In the housing association sector there have been no defaults affecting a lender or investor in the last 40 years. |
