A much stronger system of mortgage regulation looks inevitable, following the publication of the Turner Review of banking. Borrowers requiring large mortgages as a proportion of a home's value or their household's income will be more likely to have their applications rejected.
New broom sweeps away
Lord Turner is chairman of the Financial Services Authority, which is widely regarded as having failed to regulate banks sufficiently rigorously for several years. As the recently appointed FSA chairman, Lord Turner is a new broom who wants to sweep clean.
Banking regulation was flawed in principle, suggests Turner, because regulators and politicians believed that banks and banking markets would mostly regulate themselves. In practice, they did not - getting involved in financial engineering that added to their declared profits, but which added little or no social value. Regulators focused not enough on the activities of individual firms, considering instead (inadequately, as it turned out) the health of the market as a whole.
In future, says Turner, banks should store more of the profits they earn in good years to be held in reserve against potential losses in the lean periods. Banks will have to meet stricter liquidity requirements, with reserves held in funds that are easy to access.
Focus on risk
Of enormous significance to the mortgage market, Turner also proposes that lenders will have to focus more on risk. That will reduce the ability of banks to buy and sell securities that package up mortgages - the process that brought the financial system down in the first instance.
Banks are also likely to have to change their approach to other high risk activities. These will include very high loans to values on mortgages; the self-certification of income on mortgage applications; and high ratios of loans to income. In addition, credit card lending is likely to become more restricted, potentially affecting home buyers' capacity to fit-out new homes.
More detail on the regulation of the high risk areas of mortgage lending will be considered in a 'mortgage market review', scheduled for publication in September. This could see the lending of 'second charge' and buy-to-let mortgages fall within the remit of the FSA. It may also stipulate a regulatory limit on permitted loans to value and a minimum household income as a proportion of loans.
'Profound change'
Lord Turner suggests that the impact of his proposed reforms should not be underestimated. "The changes recommended are profound, and the banking system of the future will be different from that of the last decade," he says. "The world’s economy will be better served as a result."
The review was widely welcomed as forming the basis for a fresh start by the FSA. But the Financial Services Consumer Panel - which feeds an independent, consumer-based, view into the FSA - says it does not go far enough. There should, it believes, be a recognition by the FSA that in the past it did not act sufficiently in consumers' interests. This was evident, it argues, from the extent of mis-selling of mortgages and other financial products.
Threat to consumer choice
But Ray Boulger of mortgage brokers John Charcol warns against the mortgage product review coming down to heavily regarding loans to value and minimum incomes for borrowers. "There is a lot of common sense in this report, but also dangers in some of the issues flagged up for discussion, in particular the possibility of regulating mortgage products and imposing caps on LTVs and/or income multiples," he says.
"However, the fact that the report has already identified some of the negatives of going down these routes is helpful. For example the report warns that with a cap on LTVs, useful tools like consolidation will be in jeopardy. It also points out that by limiting income multiples the 'democratisation of home ownership' will be adversely affected."
Boulger welcomes the report's recognition that caps on LTVs risks pushing borrowers towards making up the difference through unsecured loans at much higher rates of interest. He adds that excessive mortgage product regulation and caps "are a thoroughly bad idea and will reduce consumer choice".