Bank of England issues warning against bad loans and tightens mortgage affordability tests

29 June 2017

The Bank of England is to force banks to hold bigger reserves against consumer loans, amid fears that lenders are unprepared for future financial shocks.

The central bank’s Financial Policy Committee (FPC) has taken this action after a rapid rise in the amount of credit taken out by consumers.

It says the market – which includes credit card debt, personal loans and motor finance – grew by 10.3% in the year to April, much higher than general wage growth. Consumers currently owe £198 billion to lenders.

The industry as a whole will be required to increase its reserves by £5.7 billion in the next six months and put aside a further £5.7 billion by the end of 2018.

Mortgage stress tests tightened

Separately, the FPC also tightened the rules concerning how mortgage lenders stress test their customers. Banks and building societies will now be required to check that a borrower can pay back their loan both at today’s rate, and also if the lender’s standard variable rate (SVR) was to be 3% higher than its current level.

The current rules are open to interpretation, which had led to some lenders stress testing customers at 3% above the initial mortgage rate, rather than 3% against the higher SVR.

However, the Bank of England says the new stricter interpretation of the rules is expected to have minimal impact on lending. It says that only 0.5% of loans granted in 2016 would have been turned down based on this new stress test.

The tightening of the rules comes despite trade body, the Council of Mortgage Lenders, calling for these tests to be relaxed earlier this year as it’s worried the rules are making it too difficult for people to take out a mortgage.

‘FPC is committed to ensuring system can withstand potential shocks’

Bank of England governor Mark Carney says: “The resilience of the UK financial system has strengthened significantly since the crisis. As a result, it has demonstrated its ability to dampen, rather than amplify, the impact of shocks on the real economy.

“As the UK moves into a more standard risk environment and embarks on the Brexit process with its attendant tail risks, the FPC is committed to ensure that the system continues to have sufficient resilience to withstand potential shocks.

“By taking the measures announced today and overseeing contingency plans for Brexit, the FPC will help ensure that the people of the United Kingdom can move forward with confidence that they will be able to access the financial services they need in order to seize the opportunities ahead.”

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