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Speech by Jon Pain, Managing Director, Retail Markets, FSA
CML annual conference
2 December 2008
Good morning, it is a pleasure to be here again. It is a bit déjà vu but I now find myself looking at the market from an FSA perspective. While it feels odd to be here as guest speaker, I am delighted the CML has invited me back.
My new chairman at the FSA – who, like me, joined in September – said that joining the FSA in the current market was like getting on board a rollercoaster. I know how he feels. And I expect many of you have had the same breathless journey this year.
Last year at this conference, from a different view point, I spoke of an unprecedented two years, with gross lending up 25%, the broadening of the mortgage market with new lenders and product innovations, and the bedding in of FSA regulation. That was the good news. I also said the repercussions from the global credit crisis would have a profound and lasting effect, not realising quite what that would really mean.
It was clear to all of us that although, we had enjoyed a favourable combination of historically low interest rates, low unemployment and strong consumer confidence, alongside growing wholesale funding markets. The good times were actually behind us. 2008 was going to be a lot tougher.
But who could have predicted just what 2008 had in store for us. Little did we know that we would see the announcement of a merger of the country’s biggest mortgage lender, HBOS, with Lloyds TSB, who had, like the Royal Bank of Scotland, become part-nationalised. While Bradford & Bingley was fully nationalised and another mortgage bank, Alliance & Leicester, taken over by Santander. And you can add to that several building society mergers announced this year. Then, there is the staggering £180 billion fall in the market capitalisation of our top six banks’ since before the crunch. We truly have seen a profound and lasting effect from the credit crisis, resulting in the demise or merger of all of the demutualised building societies and their failed business models.
Against the backdrop of the deepening crisis, the government announced on 8 October they would put in place a £500 billion plan to support the UK banking system.
Now we face a recession, how long and how deep is unclear. I believe the support provided by the government to the banks and building societies will have the desired effect, but it will take time and market volatility will continue for some time to come.
And it's obivious the market, following the significant investment from government, has to look at and learn from recent events, particularly on responsible lending.
Indeed, there are clearly lessons for us all to learn. We at the FSA need to make sure regulation is focused on where the risks really are. We will look at our capital adequacy regime, liquidity and firms’ business models. But not lurch away from conduct of business issues. We at the FSA have lessons to learn and we have already acknowledged this.
We need to do all we can to prevent such extreme events happening again and to ensure that we and the other tripartite authorities are better equipped to deal with banks and building societies in the event we were again to encounter such extreme difficulties.
We have introduced already many changes to the way we supervise high-impact firms with our supervisory enhancement programme.
The more challenging and difficult task will be modernising global regulation. There is no question that this has been a global failure and that all elements of the framework need to be looked at. We will play our part, working closely with colleagues around the world, and we support plans for more co-ordinated efforts to supervise cross-border firms that pose a systemic risk. We will publish a discussion paper next year on the regulatory framework and addressing the issues arising from the global financial crisis.
What about issues closer to home –
We have already today heard how mortgage lending has fallen over the past year. Our hosts predict that gross lending will be around £255 billion this year. That's a considerable fall of 30% compared to last year, and most expect things will get worse before they get better. The outlook for next year looks even more difficult and we could easily see a negative net lending market.
Falling house prices and global recession, are going to put further pressure on lenders and borrowers.
We will be looking at how you deal with these pressures. One response has been to rein-in lending – as we predicted in our Financial Risk Outlook, at the beginning of the year. Many lenders have learned the lessons we highlighted in our responsible lending work, which found that more caution should have been applied when lending.
Loan-to-values in excess of 100%, a failure to check on borrowers’ income and affordability, and focus on high-growth – and high-risk – subprime meant that some lenders – in particular specialist lenders – lost sight of the risks they were taking on as they aggressively competed for new business. Many areas of these markets have now dried up completely. But let me be clear, we are perfectly happy and want to encourage growth in mortgage lending that properly reflects the price of risk.
And there is no doubt that during the boom years the number of mortgage intermediaries grew to levels that we can all now see, in hindsight, were – like some of the lending that resulted – probably unsustainable.
We have now seen much of this unravel. Mortgage approvals are falling, with lenders concentrating their efforts on securing the lowest-risk borrowers, and the number of brokers is falling. The lending market is now wholly dominated by probably six large, balance sheet lenders. And with the recent pass through of the Northern Rock Granite structure, we are unlikely to see any early, restoration of securitisation markets. Although, we do welcome the Crosby review and the debate it will generate.
A word on arrears and TCF
As the financial crisis hits the real economy, unemployment is rising, bringing with it an increase in the number of borrowers struggling to meet mortgage repayments. And with falling house prices fall we have seen some lenders tempted to take swift action on arrears and repossessions to minimise losses.
I have a clear message here and that is, in such a challenging operating environment, it is particularly important that you focus on the fair treatment of your customers when they go into arrears.
I am pleased to see the CML recognise the importance of this, and I welcome their recent guidance to lenders.
And to illustrate how important we believe it is, we have recently sent a Dear CEO letter to the chief executives of all lenders to remind them of their responsibilities. We have done this because, although our work on arrears earlier this year found specialist lenders had the most to do to improve practice, no lender should be complacent, and across all sections of the market we have found firms that need to make improvements.
We want each lender to look at their internal arrears policy to ensure it aligns with the mortgage rules and treating customers fairly. Then to review actual current practice to ensure in these more testing times corners are not being cut.
If you have customers in financial difficulty, we expect you to make efforts to reach agreement with them, adopting a reasonable approach to the time over which any shortfall in payments can be made good. And to only take repossession action where all other reasonable attempts to resolve the position have failed.
The Civil Justice Council's new pre-action protocol, for courts in mortgage repossession cases, has reinforced this.
Of course consumers in financial difficulties have a responsibility too, and we are telling them to engage with you and face up to problems as soon as possible.
You will also be aware that we have recently announced that from next year we shall be including treating customers fairly within our core supervisory work, making it an integral part of our ARROW framework. That’s an acceleration of our original timetable. I think it’s more appropriate that treating customers fairly sits in our core activities of supervision rather than continuing as a standalone project.
I said recently our new retail strategy would be specifically focussed on customer outcomes. And we would be more productive and make appropriate interventions faster. One such area has been on unfair contract terms for tracker mortgages. Whilst tracker interest rate floors can be a legitimate term of a mortgage, it can only be if it – clear and unambiguous to the consumer, is consistently and prominently spelt out in the initial KFI and offer document throughout the sales process. If it is not you run the real risk of both breaching our disclosure requirements and having an unfair contract term you can't enforce. I am well aware of potential systemic risk, some lenders face in a very low interest rate enviroment. But the solution cannot be to to introduce contract terms that don't exist or uninforcable.
But what about the future?
There are difficult questions facing us about the future of the mortgage market, in particular what sort of mortgage market we want to see emerge going forward. It is unlikely to be anything like the recent past.
People ask us, should we ban self-certification mortgages? Should we stop lenders offering 100%+ mortgages? Should affordability tests be more rigid? How do we balance the needs of non-standard customers with lenders’ lower risk appetite. Should we look more like a product regulator.
I don't think we should answer the questions piecemeal – now is the right time for us to address the big issues, and I believe we have a market with the CML that is willing to take an open mind and collaborate with us, learning from the past, and making sure that we get a more sustainable market in the future. Where lenders have adequate liquidity, funding and capital; strong systems, customers enjoy the benefits of a vibrant market but are not exposed to unnecessary risk.
So we will be standing back and reviewing the future shape of the mortgage market and how far our intervention should reach, to help shape these outcomes.
Brokers will continue to have an important part to play. Some people have suggested that brokers could slip under the FSA’s radar with all of the focus at the moment on larger, higher-risk firms – although of course, brokers say we focus too much on them. Let me reassure you that our focus on the intermediary markets has not reduced. We have done an awful lot of work with brokers since we began regulating them four years ago and that will continue. Added to this, our enhanced strategy for small firms will ensure that all brokers get a treating customers fairly assessment over the next two years.
Conclusion
So in closing, this is one of the many ways we hope to work in partnership with you to improve the mortgage market making sure that when market conditions improve the industry is stronger and has better control of the inherent risks involved in mortgage lending. And, of course, consumers continue to benefit from one of the most important segments of the Retail Financial Services market.
Thank you for the opportunity to speak today, and I look forward to hearing thoughts and questions.