So it was with page 64 of November’s Financial Stability Report, which set out a plethora of policy possibilities for 2014. The Financial Policy Committee has bared its teeth – and they are sharp.
The list of “potential future tools” included more than just the standard directions on minimum capital buffers required to fund mortgage lending. There were also recommendations on minimum standards for interest rates used in affordability tests and recommendations on maximum loan-to-value, loan to income and debt to income ratios allowable.
Contrary to popular perception, the Bank can intervene in Help to Buy at any time, not just at the time of the official annual review. Page 64 says: “The FPC has the power to make recommendations on the scheme at any time”. If it deems at any point in the year that risks to financial stability are building, it will act.
Do we know anything about the potential impact that some of these tools might have on the mortgage market? A little. Such policy options do have a limited history, largely in Asia and Central and Eastern Europe (and notably also Canada). Preliminary evidence from the Bank for International Settlements suggests that the one to watch out for is precisely the one that the Financial Stability Report put banks on notice about.
In the study of 57 countries since 1980, it finds that affordability tools, in particular targeting debt service to income ratios, are the most effective at limiting housing credit growth. LTV limits also matter to some degree, but are less powerful. The logic for the result is straightforward.
A debt service based limit is unaffected by rising house prices, meaning that households can’t borrow more as prices rise. In contrast an LTV based limit allows households to raise their borrowing somewhat if house prices are growing. The debt service based limit therefore has a greater constraining effect on housing credit.
It is financial rather than monetary policy that will most likely be the major policy factor affecting the housing market in this year and the years ahead. The FPC is building its toolkit. It would be wise for us all to pay attention to what might be included. It would be wise to pay attention to page 64.
Rupert Seggins is senior economic advisor at the Royal Bank of Scotland