The above headline is taken from the English tabloid Daily Mail which claims that the new FCA responsible lending rules under the Mortgage Market Review have resulted in long and detailed questioning of potential borrowers on their household outgoings. The Financial Times on May 17th reports a lending logjam as a consequence of the stricter and more exhaustive lending criteria.
The affordability rules (for those interested in the detail see here ) are the target of attack. These require lenders to verify household income and ensure that the mortgage is affordable taking into account borrowers’ ‘committed expenditures’ and ‘basic household expenditure’. The lender may not rely on capital appreciation as a basis for lending and must take into account market expectations of future interest rate increases over a minimum period of five years. Self-certified mortgages are prohibited and interest only mortgages are only permitted if there is a clearly understood and believable alternative source of capital repayment.
These rules were developed through a process of consultation including an impact analysis which estimated the extent of market exclusion in both subdued and boom markets. The overall exclusionary impact was predicted to be most significant for credit-impaired consumers rising from 10.5 percent in a subdued market to 69.7 percent in a boom. This was the sector which had exhibited the poorest underwriting standards ‘in some cases bordering on the predatory’. The impact on first time buyers was much smaller rising from 0.9 percent to 10.5 percent in a boom period.
The media may simply be pointing to teething problems in implementation. However other issues may be raised. First, the potential difficulties of maintaining political support (at least in the UK) for rules which exclude individuals from the market. The justification for the rules are clear–to avoid future problems with repossessions, debt difficulties and default as well as ensuring the capital stability of financial institutions. Given the importance attributed to home ownership in England– and the many business and financial interests associated with the housing industry as an ‘engine of growth’–political pressure may build both to reduce the impact of the rules and at the same time challenge the authority of the regulator. The ideology of access and choice has been the norm since the deregulation of the mortgage market in the 1980s. As the memory of the Great Recession becomes dimmer, particularly among first-time buyers, we may witness continuing attempts to reduce the effects of these changes.
A second issue concerns the most effective method of implementing the concept of responsible mortgage lending. The UK model tracks the G20 Financial Stability Boards principles on sound residential mortgage lending but does not adopt sharp loan-to-value limits or debt-service ratios which exist in countries such as Canada and Japan. The FSA (now FCA) rejected loan-to-value limits, notwithstanding the evidence of a relationship between high LTVs and arrears, because of the potential impact on first-time buyers. Strict debt-service ratios were rejected because of the perceived weakness of correlation between high debt-service ratios and arrears and the over-inclusive nature of this approach (i.e significant numbers of ‘good’ borrowers might be excluded; see here at 55-59). The advantages of strict bright line rules over the affordability tests are in theory their simplicity and reduced compliance costs. The disadvantage is that they are inevitably over-inclusive. Whichever system is adopted will present ‘gaming’ opportunities. The web already reports on methods to avoid the requirements.
The UK developments anticipate the implementation of the EU Mortgage Market Directive (see recent post here) and the approach of the Directive reflects the influence of the FCA in its approach to assessing creditworthiness. Responsible lending is now a worldwide phenomenon. The World Bank now has a responsible finance site including a study which indicates the world-wide growth of responsible lending provisions since the Great Recession with an increase from 20 to 40 countries imposing explicit limits such as loan-to-income ratios. There is a need for systematic comparative analysis of the different approaches and their effects in emerging as well as mature credit markets.