A bank’s commercial 'north star' is its return on tangible equity, which is the annual profit it generates for each pound of shareholder capital that it holds.
The regulator, in the form of the Prudential Regulatory Authority, determines how much equity capital (the denominator in this all-important profit calculation) a bank needs to hold for each loan they issue.
Recent years have seen banks transition to a new regulatory framework (advanced internal ratings-based models), that has radically reduced the capital requirements for low-risk mortgage lending.
For a mortgage with a deposit of 10 per cent or 20 per cent – your typical first-time buyer product – banks using AIRB models on average must hold £0.22 for every £1 they lend.
But increase that deposit to 30 per cent and the bank only needs to hold £0.12 in the pound. Where the value of equity in the home is greater than 50 per cent, a bank holds just £0.05 for every £1 lent.
Banks have been incentivised to plough capital into low loan-to-value lending, pushing down interest rates for home-move and remortgage customers while making products that serve first-time buyers comparatively less attractive.
The winners are existing homeowners sitting on handsome amounts of home equity.
The good news is that some of our major financial institutions are now putting social impact high on their list of priorities, bringing ethical considerations to bear on their capital allocation decisions.
Legal & General’s homes initiative is bringing much-needed supply to the housing market and Lloyds Banking Group is delivering on its ambitious lending target for first-time buyers.
But as lenders, we can and should be doing much more, being bolder and more imaginative in our thinking. We need new, truly customer-centric business models that support aspiring buyers every step of the way.
We must strive to create a just society in which everyone can have a stake in the property they occupy. To do this we must reinvent housing, not just home finance.
Will Rice is co-founder and chief executive of Generation Home