In its response to the Basel Committee on Banking Supervision’s (BCBS) recent consultation, the UK’s Council of Mortgage Lenders (CML) has warned that the proposed reforms could have “unintended and negative consequences” for prime residential and buy to let markets.
The CML submitted its response to the consultation document, Revisions to the standardised approach for credit risk, last week.
In it the Council argues that the significant increases in risk weightings proposed by the BCBS for both prime residential and buy to let lending are not justified by historic losses and questions the method used by the BCBS to calibrate its proposed risk weightings.
“In current market conditions, mortgage funding is available and attractively priced, and UK consumers are enjoying some of the lowest rates ever. But capital requirements that are excessive relative to the risk of the underlying assets are likely to affect the cost and availability of mortgages.”
The proposed reforms also make insufficient allowance for the mortgage regulation which has already been reinforced in the UK, says the Council and it cites the Financial Conduct Authority’s (FCA) mortgage affordability stress tests as an example of this.
“Without taking into account the effects of reinforcing UK regulation, the changes proposed by the BCBS are being presented in a ‘regulatory vacuum’.”
The Council also raises concerns that the proposed rules do not reflect the fundamental differences between the UK’s residential and buy to let markets.
Although buy to let volumes are often more volatile than in the residential sector, this does not always imply greater risk.
“The buy to let market tends to respond more rapidly than the residential sector to rising interest rates, for example. But this may simply mean that buy to let is more efficient in adjusting to evolving market conditions and quicker to recover its equilibrium.”
The CML explains that most buy to let loans are advanced on an interest-only basis.
As such, lenders have different strategies for recovering arrears. For example, in some circumstances a lender will appoint a receiver of rent to guarantee that rent recovered from tenants is used to pay off the mortgage.
Buy to let risks cannot therefore be compared with those of the residential market says the CML, stating that data collected from lenders using internal ratings-based methodology in the buy to let sector are likely to provide the best evidence of risk.
When reviewing the use of data in the BCBS’s consultation, the CML highlights the fact that there is currently a lack of ‘robust’ figures over the buy to let cycle, which it feels presents challenges in trying to establish appropriate risk weightings.
Without secure data, the Council says that the risks associated with new buy to let mortgages of 60% LTV to 80% LTV cannot be seen as being two to three times greater than they were in the past, which is what is implied by the BCBS’s proposal to raise the risk weighting for these loans from 35% to 90%.
“As we have proposed for the residential sector, we would like to see individual buy to let loans broken down into segments, to get a more detailed picture of differences in risk as the LTV ratio rises. This would enable regulators to develop a more nuanced view of risk across the market, and apply appropriate risk weightings.”
The CML firmly concludes that the committee’s proposal for reforming the standardized approach to assessing credit risk would have unintended and negative consequences for both prime residential and buy to let lending in the UK, arguing that there is a risk that the committee will be operating in a regulatory vacuum if it fails to take into account reforms that have already been introduced in the UK market.
“Currently, we believe that the capital weightings being proposed are based on a flawed understanding of risk in the UK. If the committee introduces reforms that do not properly reflect UK market conditions, there is a risk of significant detriment for both consumers and firms.”
The CML has suggested a number of reforms to the BCBS proposal, and hopes to work with the Basel authorities to implement rule changes that reflect the needs of consumers and firms in the UK.