According to the Bank of England’s latest Financial Stability Report, risks remain within the financial system.
It has warned historically low levels of interest rates globally and the current backdrop of low volatility across financial markets may encourage market participants to underestimate the likelihood and severity of tail risks. There are increasing signs that investors, in searching for yield, may be increasing the vulnerability of the financial system to shocks. This vulnerability is amplified by structural changes in markets potentially reducing the availability of market liquidity at times of stress, it says.
The FPC does not believe that household indebtedness poses an imminent threat to stability. But it has agreed that it is prudent to insure against the risk of a marked loosening in underwriting standards and a further significant rise in the number of highly indebted households.
The FPC has recommended that when assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be three percentage points higher than the prevailing rate at origination.
It has also recommended that the PRA and the FCA should ensure that mortgage lenders limit the proportion of mortgages at loan to income multiples of 4.5 and above to no more than 15% of their new mortgages.
The central bank believes these steps will be supported by the UK banking sector stress-test exercise, to be completed by the end of 2014, which will assess the resilience of UK banks to a marked fall in house prices and substantial increases in interest rates.
Mark Harris, chief executive of mortgage broker SPF Private Clients, said: “It is surprising that the Bank of England feels this move is necessary. The heat has clearly come out of the housing market and virtually all mortgages are now done on a repayment basis. Borrowers are opting for fixed rates and when interest rates start to rise, wage inflation will improve. With all this going on, it is not clear why the Bank feels the need to get involved; lenders are broadly sticking to these suggested restrictions anyway.
“There does need to be flexibility for high-net-worth borrowers. Many outgoings are fixed outgoings: if you are earning £40,000 you might not be able to afford 4.5 times income but if you are earning £400,000, it might be perfectly affordable to take on a mortgage that is six times your income. Someone living in a four-bed house in Barnsley will have similar outgoings to someone in a four-bed house in Fulham but it will be worth much less and their earnings are likely to be much lower. The mortgage market review has an exception for HNW borrowers but lenders seem reluctant to use it.”
