The Bank of England’s warning from history to mortgage lenders
The Bank of England’s warnings about the rapid rise of UK household debt have become increasingly prominent of late.
In a recent speech, an executive director at the central bank raised yet another alarm about household debt levels – and why mortgage lenders need to pay attention.
Alex Brazier, executive director of financial stability, was the latest senior individual at the central bank to sound the alarm on Britain’s appetite to borrow. In a speech delivered at the University of Liverpool’s Institute for Risk and Uncertainty, Brazier reflected on how the behaviour of borrowers with chunky mortgage debts can set off a chain reaction.
It was clear though, that he was worried about the propensity of the average borrower to repay their mortgage debt. He said: “It doesn’t take a genius to know that households with big mortgages are more vulnerable to the unexpected.
“In Britain, they do everything they can to pay their mortgage debts through thick and thin. That is why banks did not take large losses on mortgages in the crisis. But that does not mean there is no risk to the wider economy.
“Far from it. In the face of unexpected events, they cut back sharply on all other spending to keep paying the mortgage. Although no individual household can shape the wider economy, if large numbers feel forced to behave like this, they can affect everyone by making economic downturns deeper.”
Brazier explained that the evidence from the financial crisis is that households with big mortgages cut their spending “six times more aggressively” than households with no, or at least small, mortgages.
This effect of high mortgage debt on economic risks, he added, is reinforced by another. Brazier believes that high by making downturns deeper, levels of mortgage debt raise the risk to banks of losses on all their non-mortgage loans, from company debts to credit cards.
He added: “Without the strength to face those risks, banks are more vulnerable to the unexpected. When the unexpected happens, they do what they did in the financial crisis. They cut back their lending, making downturns even deeper. Unlike mortgages, high levels of consumer debt are a danger to the wider economy primarily through this channel of losses to banks.”
Brazier said an “enlightened lender” should factor in the risks of losses on the rest of their business from high levels of mortgage debt.” And in a clear warning about complacency, he highlighted a page from the 206 Annual Report of Northern Rock which stated: “The credit quality of our assets remains strong… the reason for this improvement is… because we have improved our credit scoring.”
Brazier’s speech came less than a month after the Bank of England’s move to tighten mortgage affordability rules, in a bid to prevent loosening underwriting standards. Previously, banks were expected to test affordability among borrowers by checking how they would cope with a three percent increase in base rate. The new rule will require lenders to assess how borrowers would handle a three percent rise in firms’ standard variable rates.
The Bank of England has in fact fired off several warning shots about consumer credit levels in the past two months. Governor Mark Carney told the world’s media at the end of June that lending conditions in the mortgage market were becoming easier, and that lenders may be “placing undue weight on the recent performance of loans in benign conditions.”
Some of the changes the bank is forcing through will mean lenders will need to set aside as much as £11.4bn of extra capital in the next 18 months.