The international regulator charged with overseeing financial stability has unveiled a set of common-sense principles about how mortgage loans should be made, with the aim of preventing another housing boom and bust that infected global banking systems.
The Financial Stability Board, a group of regulators organised under the Bank for International Settlement in Basel and which is charged with devising broad rules to prevent another crisis, published a seven-point bulletin of principles designed to be flexible enough to allow for differences in nations’ housing markets.
But some of its principles – such as those requiring lenders to check whether borrowers can repay their debts or that regulators require banks to undertake sound appraisal standards when considering whether to extend a loan – were rarely relaxed in many jurisdictions before the housing boom that swept through the US and parts of Europe over the past decade.
The principles include lenders checking that borrowers do indeed earn the income they claim and keeping the documentation that proves it. Moreover, they should take account of a borrower’s ability to repay their mortgage when other financial commitments, such as insurance and taxes are also included. Also, lenders should be required to provide borrowers with clear information regarding the characteristics of the loan they are seeking.
The principles stop short of addressing one of the most controversial proposals that has arisen in some jurisdictions: whether regulators should set a ceiling on the maximum loans relative to the value of the property it is being used to buy. Such loan-to-value ratios have been proposed – but rejected – by the Bank of England, which will oversee the prudential supervisor for banks.
However, noting that loans with high LTV ratios typically perform worse than those with lower ones, the principles require regulators to make sure intermediaries are incentivised to check that mortgage loans are properly collateralised. They further need to ensure that downpayments come from the borrower’s own resources, and that the home buyer has a financial incentive to keep up payments and avoid the loss of that downpayment.
Regulators are also asked to ensure that lenders do not ever again rely on a housing boom to recover the value of loans. For example, they should guard against LTV ratios becoming a substitute for sound underwriting principles with lenders’ failing to ascertain borrower income because the sum borrowed is a relatively small percentage of a property’s value. Moreover, LTV ratios should not be relaxed in a housing boom.
The principles also try to address some of the perverse incentives that slipped into the home-buying chain, particularly in the US but elsewhere as well, such as those that encouraged appraisers to adopt the most optimistic view of a property’s true value.