Speaking at the CASS Business School in London last night, chairman Adair Turner addressed the role of credit in driving asset price cycles, which he said can drive credit supply in a “self-reinforcing and destabilising process”.
However, Turned stressed that using a “one size fits all” approach to curbing asset price bubbles in commercial or residential real estate could have unintended consequences of restricting credit to other sectors of economic benefit.
Turner suggested four different macro-prudential tools, each with their own advantages and disadvantages, as potential ways of preventing future asset bubbles.
He said the regulator could look at direct borrower focused policies, such as maximum loan-to-value ratios either applied continuously or varied though a cycle. This idea is being looked at as part of the FSA’s Mortgage Market Review.
Turner also suggested an interest rate policy to take into account of credit/asset cycles as well as consumer price inflation. But he said this option has three disadvantages, that the interest elasticity of response is likely to be widely different by sector, that higher interest rates can drive exchange rate appreciation and that any divergence from current monetary policy objectives would dilute the clarity of the commitment to price stability.
Another option he suggested was across-the-board countercyclical capital adequacy requirements, increasing capital requirements in the boom years, but warned this too could cause variable effects.
He also suggested that countercyclical capital requirements could be varied by sector, increased against commercial real estate lending but not against other categories. He warned this option could be undermined by international competition.
Turner said: “There are no easy answers here: but some combination of new macro prudential tools is likely to be required. We need ways of taking away the punchbowl before the party gets out of hand. And a crucial starting point in designing them is to recognise that different categories of credit perform different economic functions and that the impact of credit restrictions on economic value added and social welfare will vary according to which category of credit is restricted.”