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Mortgage analysis: Govt wrestles with capital conundrum

George Osborne 480

Since the credit crunch, banks have been stuck between two powerful and fundamentally opposite forces from politicians and regulators.

On the one hand there are politicians desperate to get the economy growing with more lending and on the other there are regulators focusing on regulatory risks and asking for extra capital.

The capital buffer versus lending, or safety versus growth, conundrum has been and is likely to remain a big regulatory, political and economic problem for the UK.

Last month, the conflicting demands on banks from politicians and regulators came to a head and were laid bare in the space of a week.

In his Budget last month, Chancellor George Osborne put forward an ambitious plan to boost home ownership and radically boost lending on high loan-to-value mortgages.

The mortgage indemnity guarantee aims to create 190,000 mortgages and boost mortgage lending by £130bn over three years. It works by asking borrowers to stump up 5 per cent of the deposit and the Government will offer a guarantee of up to 15 per cent of the purchase price.

Just one week later, the Bank of England’s financial policy committee came forward with an even bigger plan to ensure financial stability. It told banks to raise £25bn in extra capital by the end of the year.

The FPC believes banks have under-estimated the risks from commercial property loans, the eurozone and payment protection insurance misselling claims over the next three years meaning some will not meet the 7 per cent capital ratios they need.

The FPC is doing exactly what it was set up to do by spotting risks to stability and quickly correcting them. The Government is doing exactly what it is expected to do and trying to boost growth.

Hometrack strategy, risk and economics director Gary Styles says: “It is quite odd to impose extra capital requirements just one week after announcing the need for more higher loan-to-value lending.

“On the surface the FPC demands will result in higher capital requirements for higher loan-to-value lending which will make them more expensive unless there are other specific arrangements.”

The FPC did try to placate Government policy by asking the Prudential Regulation Authority to impose the “significantly higher” costs in a way that does not harm business or mortgage lending.

But Confederation of British Industry director for competitive markets Matthew Fell says: “It is important that banks hold appropriate levels of capital to withstand any future shocks without affecting deposits or requiring taxpayer support. Failure to put adequate buffers in place can have stark consequences as we have seen in Cyprus.

“While the FPC wants banks to meet additional capital levels in a way that will not restrict lending, it is difficult to see how this can be achieved in practice.”

The Government is trying to find a third way by holding talks with the FSA about giving capital relief to banks that offer loans through the MIG scheme, a move the Council of Mortgage Lenders says is essential to its success.

Styles says: “The FPC’s move puts even more urgency on making it clear what the capital requirements are for the new scheme. Last week’s announcement means higher loan-to-value lending will require more capital so we need to specifically know the arrangements for the new Help to Buy MIG scheme.”

Capital relief could support Help to Buy but there are other pressures facing major banks as they seek to reduce their balance sheet. Lloyds Banking Group, Santander and the Royal Bank of Scotland have all made clear they have no plans to grow their books and want to reduce bad legacy loans.

Capital Economics property economist Matthew Pointon says the extra capital raising will simply cement banks’ deleveraging plans.

He says: “The big banks are already shrinking their mortgage books as they rebuild their capital positions so this is going to make that process continue.

“It is one reason why Help to Buy will not have a big impact because if big banks want to shrink their mortgage book they will do. The FSA still has to decide on capital relief for Help to Buy but even if you get relief banks will not grow their lending.”

The problems facing the UK banking system have proven too strong for Government lending schemes to overcome so far. Cabinet minister Oliver Letwin told Money Marketing last year the Government was being “experimental”, while Labour leader Ed Miliband had his fun listing the failures in his response to the Budget.

Bank of England figures show net lending to businesses and home owners dropped £2.4bn year on year in Q4 2012 despite the funding for lending scheme launching in August.

But it may not be all doom and gloom for residential mortgage lending as Styles points out the focus of the FPC report is around commercial property. It is possible that shifts in capital demands and Government incentives could have an effect.

Acenden director of business origination and development Alex Maddox says: “Residential mortgages require less capital than most other types of lending so combined with the funding for lending scheme this might encourage banks to focus on mortgage lending.

“Within residential mortgages low loan-to-value deals require less capital than higher loan-to-value so this may not help the high loan-to-value segment as much.”

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