Alex Brazier, executive director, financial stability, at the Bank of England, was speaking at the University of Liverpool’s Institute for Risk and Uncertainty.
“Lenders have not entered, but they may be dicing with the spiral of complacency,” he said.
While mortgage lending has increased by just 3% over the past year, lenders have reported that their objectives to grow market share are pressing them to make credit more available.
“Some of that fierce competition for business has shown up in reduced fees for those taking out a new mortgage. Nearly a half of mortgages were extended without fees in the first part of 2017 – four times the rate in 2011,” said Brazier.
“Boundaries are being pushed in less benign ways too. Lending at higher loan to income multiples has edged up. Over the past two years the share of lending at loan to income multiples above four has increased from 19% to 26%.”
He said in part this reflects a lengthening of mortgage loan terms, with more than a third of new mortgages having terms of 30 years or more.
Brazier said mortgage lending presents a risk to the economy as individuals cut other spending to ensure they can pay their mortgage.
“If large numbers feel forced to behave like this, they can affect everyone by making economic downturns deeper,” he said. “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.”
By making downturns deeper, high levels of mortgage debt raise the risk to banks of losses on all their non-mortgage loans, from company debts to credit cards, added Brazier.
He warned that in a period of good economic performance and low loan losses, lenders can enter a “spiral of complacency”, thinking they can reduce prices and loosen lending criteria. As credit becomes cheaper, it’s taken up more widely and is serviced more easily.
“The spiral continues, and borrowers rack up more and more debt. Lending standards can go from responsible to reckless very quickly. The sorry fact is that as lenders think the risks they face are falling, the risks they – and the wider economy – face are actually growing.”
Brazier highlighted the lines of defence put in place by the regulator, including direct restrictions on high loan to income mortgage lending.
Under these lines of defence, lenders should not extend more than 15% of their new loans at or above 4.5 times the borrower’s income. Plus, borrowers are subject to an affordability test that effectively varies that loan to income limit for their individual circumstances, he said.
The Bank has already raised the capital buffers banks are required to hold on all their lending, and has accelerated this year’s stress test of their consumer credit loans.
“By September we will have assessed whether the rapid growth has created any gap in the line. If it has, we’ll plug it,” said Brazier.
However, he added that the defence lines may be starting to kick in, with consumer credit growth showing signs of slowing.