CML news & views

At the end of this month, we will be submitting our formal response to the Financial Services Authority’s (FSA) mortgage market review. It will be a comprehensive and thorough document, reflecting many months of detailed consultation with members and representing all types of lending institution.

Inevitably, there are proposals within the review with which we will take issue. But we want to make it clear from the outset that we support the review in principle and largely agree with the FSA’s diagnosis of the problems to date.

Today, therefore, we are setting out for the record the many areas in which we agree with the review document, and with what the FSA has already done – and what we anticipate it is still planning to do – to reform the regulatory regime.

Prompt action by the FSA

Since the onset of the banking market problems, the FSA has made an encouraging series of changes to the way in which it regulates. Having identified many of the failings in its report on Northern Rock, the regulator is now pursuing an impressive, extensive and aggressive retail agenda.

• The FSA is now an intrusive, intensive regulator, which we welcome. If the FSA had focused in the past on errant firms in the way it intends to in the future, some of the problems would have been avoided.
• The FSA has embarked on a substantial programme to enhance its supervisory role. This will mean extra costs for firms and consumers but, if it results in a better understanding of the market and greater anticipation of problems in advance, the risk of systemic disruption should be diminished significantly.
• The regulator has set up a conduct risk division. This is an important development. It helps the industry understand more clearly the core problems that the FSA has identified as risks in the business conduct of firms, and which will be the primary focus each year. With better understanding of what the FSA is trying to achieve, firms will be able to give greater support to the systemic goals it is pursuing in its supervisory work.
• The FSA has strengthened stress-testing requirements for firms – and will reinforce them in future if necessary, to ensure that business models are sound through economic cycles. Firms not meeting the FSA’s requirements are being made to hold more capital, and ultimately face the threat of closure if risks cannot be properly managed. While supporting this approach in principle, we need the FSA to get the balance right. If the regulator’s stance is too risk-averse, it risks accelerating unnecessarily a process of consolidation within the industry. Bearing in mind the past supervisory failings, however, we are not surprised that the FSA’s approach is ‘safe, not sorry.’
• The FSA has introduced more rigorous approvals processes for senior management, which, again, we welcome. But we do not want to see the most talented people choosing to leave the financial services sector to work in areas where there is less personal scrutiny.
• The FSA has widened its regulatory scope and, with Treasury support, will do so again in the future. We applaud its prompt intervention on sale-and-leaseback firms, with the rapid implementation of interim regulation to protect consumers before introducing the full statutory regime. Looking ahead, the Treasury has also said it wants the FSA to regulate second-charge lending and firms buying up existing mortgage books. We support those aims, too, although we are less convinced that there is a compelling case to regulate the commercial buy-to-let market.

Lenders support change

Given our support for change on the scale already implemented by the FSA, it should be clear that we are not in favour of the status quo. The CML – and individual firms within the industry – recognise and accept the need for change, and this will be reflected in our response to the review.

The reality is, of course, that the market has, in any case, already changed irrevocably. It simply cannot return to the funding environment or the irrational pricing and borrowing practices that we saw up to 2007. There has been a substantial shrinkage in the source of mortgage funding and the number of active firms in the market. This self-correction will not magically reverse itself simply because the economy improves at some point in the future.

So, in acknowledging and supporting much of what the FSA has already done to address the problems that were systemic and related to businesses specifically, what do we need from the regulator in the future?

The FSA’s view

At our annual conference at the end of last year, the FSA’s managing director of supervision, Jon Pain, said that, while the mortgage market historically had worked well for many people, it had failed a minority. He is right.

We accept that some firms with high-risk strategies overlooked some of the basics of mortgage lending: effective credit underwriting and pricing for risk, and proper control of the application process. Those lenders were found out, and are now largely out of business.

Now, the remaining firms who lent responsibly have to deal with the regulatory consequences. And that is the crucial challenge for the mortgage market review: to balance the need for a regulatory reaction with the reality that the firms left largely did not make the mistakes of the past.

Given the range of possible regulatory and prudential reforms that we could yet see, there is a real risk of unintended consequences for the mortgage market that could undermine some of the FSA’s good work since the onset of the crisis in 2007. It is crucial that the proposed treatment – whether it emerges from the mortgage market review or from other regulatory intervention – does not do further, unintended harm to firms or current or potential borrowers.

It is essential, therefore, that we get the right regulatory response. As Jon Pain acknowledged at our conference, a market in which only a handful of lenders are active and competing does not address the key issue of consumer detriment and cannot be the right outcome for customers. What the review should deliver, he said, is a market that is “flexible, sustainable and works for consumers.” We agree.

Addressing consumer detriment

We have argued consistently that change should be driven by careful analysis and a clear understanding of the causes of consumer detriment. What no-one needs is regulation driven by political rhetoric. The FSA is therefore to be congratulated for not imposing limits on lending relative to property values or income, as some ill-informed commentators have suggested. There is also no case for a comprehensive re-write of the mortgage conduct of business rules.

If we are to get the right outcome – change based on a proper understanding of the causes of consumer detriment – then whether or not it emerges from the mortgage market review is also essentially irrelevant. The key questions are these: can the FSA build effectively on the changes it has already implemented, and will it be a more effective regulator in the future than in the recent past? The only acceptable answer to both questions is: yes.

There is, however, a real risk that a new Conservative government will move the regulatory deckchairs and subsume the FSA’s functions in other regulatory bodies. We are not convinced that this is the right approach bearing in mind the scale of work in responding to past systemic failures. It feels more like an unwelcome distraction.

Conclusion

The FSA deserves credit for much of what it has already done in response to the crisis since 2007 (recognising that it failed in its tasks before that). We are, however, still a long way from a properly functioning, healthy and competitive mortgage market that maximises the potential benefits for consumers.

We do not need to rush to reform. We accept that further regulatory reform is inevitable, but we must not forget that the market has already adjusted irrevocably to correct many of the mistakes of the past. In considering further reform, we welcome the FSA’s acknowledgement of the need to take into account market conditions, the impact on competition, and developments in Europe.

The FSA is determined that past mistakes are not repeated. We agree, and we are ready to help reinforce the progress made since 2007. Working together, we have come a long way through the crisis. But the next steps are crucial.

Our response to the mortgage market review is based on comprehensive consultation with all types of lender, large and small, with a range of different business models, funding mechanisms and commercial strategies. Our aim is to help re-build a healthy mortgage market in which different types of firm can offer the benefits of competition and choice to consumers, with all the right safeguards in place.

There are still some landmines for the FSA to avoid. We are all working for a stable market that helps re-build confidence, but we do not want mortgages to be limited to the privileged few who have parental support, never lose their jobs and have only the most conventional financial needs.

Once we had a mortgage market that was the envy of the world. It is not too late to restore it. And the mortgage market review can make a significant contribution by delivering regulatory reform that addresses the real market failings. But it also risks accentuating the unwelcome trends we have seen in the past few years.

The mortgage market is going though a period of fundamental re-adjustment. So far, so good. But the FSA, and the industry, have a long journey ahead to return to ‘normality.’ Our response to the mortgage market review will highlight the short-term priorities and how, working together, we can reach an outcome that delivers the FSA’s aims as part of the review process.