The Bank of England’s Financial Stability Report (FSR) that was released yesterday focused on rising levels of indebtedness and higher loan-to-income multiples for new mortgages, but the new rules that it puts into place for banks reflect standard risk management practices. Aside from showing that the Bank of England is taking a macroprudential approach to risk management, the new rules seem to be a defensive move to make sure that current trends don’t get out of hand.
Bank of England: UK housing market growth associated with rise in mortgages
“The recovery in the UK housing market has been associated with a marked rise in the share of mortgages extended at high loan to income multiples,” says the FSR. “At higher levels of indebtedness, households are more likely to encounter payment difficulties in the face of shocks to income and interest rates. This could pose direct risks to the resilience of the UK banking system, and indirect risks via its impact on economic stability.”
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Bank of England: Risk management rules less restrictive than some bank’s internal policies
The first change is that the Bank of England’s Prudential Regulation Authority and Financial Policy Committee have set an 85% cap for mortgages with an loan-to-income (LTI) ratio multiple above 4.5x. This is more of an issue in London where housing prices have been growing faster than the rest of the UK, but even there many banks have enforced a 4.0x LTI limit.
Second, mortgage lenders have to conduct stress tests on new loans assuming a 3% interest rate hike above the base rate for five years after the start of the loan.
“It is our understanding that these type of interest rates stress tests are common practice in banks’ internal risk management, so again we would see the impact of such a measure as relatively limited,” writes Credit Suisse analyst Carla Antunes-Silva.
The Financial Policy Committee also set the countercyclical capital buffer as part of its new regulatory authority, but it set the buffer at 0%.
Bank of England: Dividends the bigger issue for UK banking sector
Antunes-Silva doesn’t rate any UK bank as Outperform, but expects the FSR to be seen as a positive for the Neutral-rated Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY). She says that investors watching the UK banking sector should be most concerned about when Lloyds and Barclays PLC (NYSE:BCS) (LON:BARC), the only UK bank she rates Neutral, will resume dividend payments. The FSR doesn’t really give them a boost, but at least it doesn’t create new hurdles they have to clear.