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Lenders overstating their mortgage risks

The Bank of England has warned that many lenders have overstated their exposure to risky mortgage securities which could delay confidence returning to the market.

In its financial stability report, the bank says an adjustment in both the price and quantity of risk-taking was clearly needed after an extended credit boom but points out that it was bound to have costs.

It says: “Estimates implied by prices in some credit markets are likely to overstate the losses that will be felt by the financial system and the economy as a whole, as they appear to include unusually large discounts for illiquidity and uncertainty.

“In effect, risk premia in some markets have swung from being unusually low to too high relative to credit fundamentals. That may be delaying the return of confidence and risk-taking.”

The report says confidence and risk appetite are likely to turn gradually as market participants recognise that some assets look cheap on a fundamental basis. However, the bank warns that, with sentiment still weak and deleveraging continuing, downside risks remain.

“Banks can further boost confidence in their resilience through more informative disclosures and by raising capital as a signal of strength in turbulent market conditions, as some are already doing.”

Association of Mortgage Intermediaries director general Chris Cummings says: “We welcome the publication of the financial stability report which states that the correction in the credit markets has gone too far and that risk appetite will return in the coming months.

“It is the AMI’s view that the bank should step in and buy more of these assets and work with the industry to set a new gold standard against which mortgage-backed securities could be repriced.”

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