BoE places ability to weather housing market shock at heart of stress tests

The FPC is designing separate stress tests with the Financial Conduct Authority (FCA) that will be used by UK banks to assess mortgage affordability. Last November, the FPC said it was working with the FCA to put in place stronger mortgage underwriting standards as part of its Mortgage Market Review, which is designed to ensure borrowers are issued with mortgages they can afford.

The FPC noted in its November Financial Stability Report that "rising house prices in a low interest environment could increase household vulnerabilities", despite tighter underwriting standards. This could pose "direct risks to bank capital" it said, and could also coincide with "large credit losses on other sections of lenders' books", especially if rising house prices had sparked a construction boom or jump in residential investment.

While the Government has given the FPC a broad range of tools that it can use to cool the housing market, including the power to vary the affordability criteria that borrowers must meet to ensure they can afford to service mortgages if interest rates rise, economists have expressed concerns that the FPC will not be able to act quickly enough.

"It is difficult to bring a decisive change in policy that could change the dynamics of the economy. You will only do it when you are really sure and by the time you are really sure it is often too late," Paul Mortimer-Lee, global Head of market economics at BNP Paribas, told the Treasury Select Committee this week.

Meanwhile, Rob Wood, an economist at Berebnberg Bank, said while the Bank could ensure lenders were well placed to cushion shocks, controlling house prices was not part of its remit. "The [Bank's] remit is to control financial stability, so if house prices crashed but banks had a lot of capital put aside to protect them from that crash then that is fine. Of course, for the whole economy a big house price crash, and certainly for households who are affected, is not fine. So in that sense we may well see action ... too late," he said.

The Bank also noted on Thursday that changes to bank regulation since the financial crisis had made it difficult to judge the impact of any future crises.

"Changes to the structure and functioning of markets as banks adapted business models to the aftermath of the financial crisis and the resulting regulatory response made it more difficult to judge the likely impact of unexpected developments from any source," the FPC said.

more