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Mortgage analysis – MMR headwinds could stifle mortgage lending

After years of wrangling and compromise, the FSA has finally published the final rules for the mortgage market review.

Lenders can now start to implement the reforms, which must be in place by April 2014.

But the regulatory headwinds for mortgages are far from over. Loan to value caps are being encouraged by the Treasury and banking reforms are on the horizon.

Hidden in the bank reforms is a very significant measure known as unweighted leverage ratios.

Leverage ratios are a backstop or a minimum capital buffer to be held against all assets regardless of risk and then topped up with risk-adjusted capital.

Basel III wants leverage ratios of 3 per cent, whereas Sir John Vickers’ Independent Commission on Banking has recommended leverage ratios of 4.06 per cent.

The higher buffer would have the biggest impact on lenders with comparatively low risk loan books such as HSBC and Nationwide. It could force them to either significantly cut theirmortgage lending or, paradoxically, move to riskier lending as the capital requitrements are similar but lenders can charge higher rates for riskier loans.

The Council of Mortgage Lenders says the current state of the mortgage market makes striking the balance between ensuring sufficient security is in place and achieving high lending volumes all the more critical.

A CML spokesman says: “It is crucial to strike the right balance as the mortgage market remains severely constrained. Lenders have been challenged by the housing minister to extend housing credit to meet the aspirations of homeowners.

“A number of our members have already identified capital requirements as a serious constraint on lending.”

Unveiling its bank reforms in June, the Government opted for a 3 per cent leverage ratio as its only major departure from the ICB recommendations, however this may change.

The EU Liikanen report into banking, published last month, recommends a review of the 3 per cent level, as does the European Commission’s capital requirements directive IV.

At home, Labour is trying to outflank the coalition parties on tough banking reforms and searching for any area that could be seen as “watering down” reforms.

Giving evidence to the Parliamentary Commission on Banking Standards this month, Vickers argued the Government should not lower the leverage ratio from 4 per cent.

He was supported by former Barclays chief executive Martin Taylor, who branded the decision to cut it to 3 per cent a “big mistake” and urged MPs to reverse it.

Former Federal Reserve chairman Paul Volcker also backs tough leverage ratios. Both men are influential and the issue is firmly back on the table.

Labour MP and commission member Andy Love says MPs are reconsidering the arguments but does not want to harm mortgage lending.

He says: “It is a matter of unanimity across the political spectrum that we would like to see more money lent to those who can afford to buy property.

“We do not want to do anything that is going to negatively impact on people’s ability to get a mortgage at a level they can afford. We also do not want to prejudice the future of the banking system so there are many pressures on us.”

Conservative MP and commission member Mark Garnier is more emphatic and argues a higher ratio will hit bank profits.

He says: “It is rather like driving down the motorway. At 70mph quite a lot of people get killed when there is a car crash so you could argue that the speed limit should be reduced to 60mph.

“But actually if you take it to reductio ad absurdum then you say there should be no cars and there will be no deaths on the road. Clearly whenever you do anything you are compromising efficiency with safety. The leverage ratio is not much different from a concept of a speed limit.”

There is a possible third way for the Government to impose a higher backstop leverage ratio but exempt low-risk lenders by creating different classes of risk.

Such a measure is being considered as part of CRDIV negotiations. Nationwide says it will “strongly” argue for distinctions based on risk if the 4.06 per cent level is re-introduced,

A Nationwide spokesman says: “Building societies, in general, have materially different risk profiles as a result of the restrictions within which they operate compared with unrestricted banks and should therefore face a relatively lower minimum.

“This could be achieved by the creation of different classes of institutions, characterised by their risk profiles, and with corresponding leverage ratios.”

This view is largely supported by the Building Societies Association, which strongly support the lower leverage ratio, but goes slightly further in saying the argument should be made in favour of differentiating models of risk assessment regardless of the agreed leverage ratio.

A BSA spokeswoman says: “We support that it should be 3 per cent not 4.06 per cent. In addition to that, our belief is that it is a bit of a blunt instrument having the same figure for everybody. We believe there should be an element of risk-related differential in terms of the business model and we argue that building societies and other mutuals have a much lower risk business model.”

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