MortgagesDec 6 2022

Beware the reckless love of the central banks

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Beware the reckless love of the central banks
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Does the right hand of central banking policy know what its left hand is doing?

I only ask because the Central Bank of Ireland has just moved to relax its affordability criteria so people can borrow four times their salary, up from 3.5. 

At a time of high inflationary pressure, and the prospect of more pain to come in 2023, this does not seem wise. 

The role of central banks in keeping the wheels of the economy rolling is apparent to everyone, whether they are in loosening or tightening mode, keeping rates low or raising them as a tool to combat inflation.

But when it comes to helping banks to do what they do, or preventing consumers - those drivers of the economy - from getting into debt, sometimes it comes down too heavily on the side of big finance and forgets the potential longer-term impact on the consumer. 

Earlier this year, when the Bank of England confirmed it was withdrawing its mortgage stress test in August, it was hailed as a sensible move by some, who felt it could help borrowers who were struggling to get onto the housing ladder.

Indeed, several even claimed it would not 'open the floodgates'. The assurances seemed to fall on ears willing to hear.

If you remember (and why would you? I barely remember my own name half the time), I wrote an op-ed calling the BoE a "reckless parent" when the stress test was dropped.

I wrote: "At a time of rising consumer indebtedness, removing any affordability criteria is not a move to be applauded."

This was long before the October inflation data came in, at 11.1 per cent CPI and 14.2 per cent RPI – a 41-year high. 

Central bank relaxation

Now the Central Bank of Ireland has joined this party of reckless love, allowing people to borrow even more than their salaries should permit, when inflation in the ROI is surging to record levels.

There are warning signs everywhere that this inflation push is just the beginning of a big fiscal squeeze on people's pockets, whether in the UK, US, Canada, France, Germany, the Netherlands, Ireland, Spain or Australia (see the chart below).

Indeed, central banks are raising rates to combat inflation - so they are aware that people's pursebelts are being tightened. 

The ramifications of Putin's war on Ukraine are global and widespread, wars and terrorist activity persist across many countries in the world, China's Covid-19 lockdowns are grinding growth to a near-standstill, and climate-change-related droughts and floods are contributing to mass migration and global disruption of supply chains. 

Because of all this people are getting into debt – and this will become even more pronounced in 2023. Will there be more repossesions and arrears caused by central banks loosening their affordability tests?

Consultancy Rockstead is understandably worried.

Its latest analysis states: "Combined with the general cost of living increases and the increase in mortgage borrowing costs, it is inevitable that the industry is facing increasing arrears, collection challenges and increased repossessions."

OECD figures

The OECD has put the UK's household debt at 148 per cent of net disposable income. This is inevitably going to rise in 2023 as the cost of living crisis bites down hard.

Desperate people do desperate things. They borrow more against their house to carry out repairs. They take on additional debts. They might even go to debt consolidators.

Buy-now, pay-later schemes are on the rise – as are scams. You see them every day on Facebook or Twitter: get-rich-quick schemes (often involving crypto) luring the unwary on the promise of finding a financial solution to their debt problems.

We have already seen lenders competing to hit more aggressive lending targets.Rockstead

The relaxing of rules around stress testing and affordability might sound like a kind thing for central banks to do. Looking just at historic statistics, it might seem like the sensible thing to do, permitting more lenders to be a bank that likes to say 'yes'.

After all, the latest mortgage data from the BoE itself stated: "The value of outstanding balances with arrears decreased by 0.7 per cent over the quarter and 7.2 per cent over the year, to £13.2bn in 2022 Q2.

"It now accounts for 0.80 per cent of outstanding mortgage balances, the lowest since recording began in 2007."

Rise in repo rates

But we don't need a crystal ball to tell us that rising debt and squeezed incomes means a rise in arrears, and a rise in repo rates. If you let people borrow way beyond their means during a cost of living crisis, you are setting them up for a fall.

It is as simple as that. It is as reckless as that.  

Rockstead's newsletter stated: "We have already seen lenders competing to hit more aggressive lending targets, risking reductions in stress test criteria which could easily result in poor customer outcomes. 

"For example, a large regional building society recently reduced its stress test percentage from 3 per cent to 2 per cent. 

"While the case put forward for the change focuses on the lender’s manual case-by-case underwriting procedures, such a move still ratchets up affordability risk."

The barriers need to be reinforced, not torn down to allow a debt-laden free-for-all, especially not at this time. 

It also raises questions about market stability and whether the banks are really able to underwrite the potential risk of this more relaxed attitude to affordability criteria.

Central banks have been our 'bank of mum and dad' since the credit crisis of 2008. They should be setting the example of financial stability and making sure that citizens are not going to get hurt because of relaxed mortgage affordability rules. 

The barriers need to be reinforced, not torn down to allow a debt-laden free-for-all, especially not at this time. 

But which lenders will stick to their posts and make sure potential borrowers will be able to afford their mortgages?

It will be interesting to see if any lenders avoid the inevitable herd mentality led by central bank recklessness, and remain firm on affordability, for the sake of their clients, their own business and market stability.

If not, this move by central banks to relax criteria may prove to have been a very bad move for hundreds, if not thousands, of borrowers.

simoney.kyriakou@ft.com