Mortgage market review and regulation of secured lending
Speech by Jon Pain, Managing Director, Retail Markets, FSA
Association of Finance Brokers,
1 July 2009
Good evening, it is a pleasure to be here at your annual dinner. I am particularly pleased to see so many of you engaging with your trade body and here this evening, because I know that trading conditions in the consumer credit market are pretty tough. The fact that you are here – and the work that the AFB is doing – shows clearly to me the desire your industry has in strengthening its reputation and putting forward the case for good, responsible second-charge lending.
Tonight I will say a few words about our mortgage market review and, while I do that, cover part of the story on the future regulation of secured lending. I say only part, because you will appreciate that the FSA is not the one that makes the decisions on how secured lending is regulated. I will also update you on our views of payment protection insurance and our approach to conduct risk.
But first it would be odd if I didn’t comment on the hurricane of a financial crisis we have just been through – the most significant post war crisis – how we have responded, and what this will mean for the future of regulation in the UK. I leave aside for now the European debate in which we are heavily engaged, as that’s a debate in itself.
Much of our early effort was focused on restoring confidence in the financial system, rocked to its foundations by what, in retrospect, were serious mistakes by financial institutions, governments, central banks and regulators, including the FSA.
We have subsequently played a leading role in helping shape the debate (through the Turner Review) on how the regulatory framework should be strengthened, and in some areas rebuilt, to avoid the likelihood of this financial crisis ever reoccurring. But though confidence is vital to the banking system, as a whole we needed to do more.
We have also needed to take a number of specific actions. Firstly, working with the Tripartite, we have strengthened both specific institutions and the financial system as a whole, through bank recapitalisation and asset-protection schemes. And critical to the effective operation of the markets has been the additional central bank and Treasury funding schemes. Addressing the capital position is essential, but as you’ll appreciate, ensuring that adequate funding is available in the market is equally important.
Secondly, where market-based solutions were not available – and again working with the Tripartite – we have sought solutions to ensure retail and wholesale depositors are protected, as in the case of Bradford & Bingley, Dunfermline Building Society and London Scottish Bank. More recently we have, alongside Treasury, developed an alternative capital instrument for the mutual building society sector – which in the case of West Bromwich Building Society allowed for the conversion of sub-debt capital into core capital, providing much needed core capital to the firm. I believe this is a strategically important solution, as it provides potential new core capital for the sector as a whole, helping to support and sustain a vibrant mutual sector going forward.
An essential element of these interventions has been a far more comprehensive stress-testing regime of the firms we regulate, to test the capital adequacy under extreme scenarios. Ongoing and in-depth stress testing is at the heart of our regulatory approach. This is a clear example of the radical change in our approach to a more intrusive style of supervision, supported by a more robust and visible deterrence regime.
But ultimately, good regulation requires good people, so we have dramatically increased the number and quality of our supervisory staff and significantly increased the intensity of our supervision. We have:
- increased the total number of supervisory staff by 33% (from 526 to 703);
- expanded our Prudential Risk division, which provides specialist expertise on prudential risks and has particular expertise in assessing complex models used in all risk categories;
- set up a specialist conduct risk division of 80 people to focus attention at the ‘coal face’ and literally test whether what senior management say is happening on the front line is true through, for example, mystery shopping, call monitoring and file reviews; and
- introduced a new comprehensive T&C regime for new and existing staff, which involves more testing and a robust assessment of our front-line supervisors.
And this more intrusive approach is already supported by a more credible deterrence regime. In 2008/09 we:
- imposed financial penalties of £27.3m up from £4.4m the year before;
- prohibited a record number of 58 individuals from industry for unacceptable conduct; and
- secured two convictions and a custodial sentence in our first criminal prosecution for insider trading.
We will continue to pursue this approach as part of our commitment to restore confidence in financial markets, to protect consumers and reduce financial crime.
So firms should expect and indeed welcome a more intrusive style of regulation, especially well-run companies. One further example has been our recent discussions on remuneration. In the past, remuneration policies have all too often not been integrated with risk management and risk appetite for firms. We have already commenced on a radically changed approach and will be making further changes in this area later in the year, which I encourage you to look out for. I believe it is important to learn lessons now from possible weaknesses in remuneration policy and practice, before things get better and memories fade. It’s clear society at large expects a step change in this area.
Mortgage market review
Let me now turn to comment on the issues closer to home for this audience – our plans for the Mortgage Market Review. It would be easy to say this looks like we are fighting yesterday’s battle and whilst I accept it is futile to attempt to rewrite history, we’re doing this because it is clear that developments in the housing and mortgage markets played a significant role in the origins of what has been the worst global financial crisis for at least 70 years.
Rapid growth of mortgage credit drove a house-price boom that turned to bust. New sources of funding were created that rapidly dried up when confidence disappeared. And confidence was undermined by lending to uncreditworthy customers, with a build-up of riskier practices, such as subprime lending, self-certified mortgages and new segments of the mortgage market, such as buy-to-let.
Our comprehensive Mortgage Market Review will look at the whole market, from lenders through to consumers’ perspectives. We will take the time to fully understand what worked well for consumers and what didn’t, and explore all of the available options for putting things right – setting out our views and proposals in a Discussion Paper to be published in the autumn.
The aims of our review are to have a mortgage market that is sustainable for all participants (consumers, intermediaries, lenders and investors) and to have a flexible market that works for consumers. As part of the review we will look at a number of issues:
- responsible lending and funding issues;
- distribution and advice;
- extending the approved persons’ regime;
- excessive charging and price regulation;
- disclosure and changing consumer behavior; and
- arrears and repossessions.
So far, our consideration of issues has also highlighted the relevance of looking beyond the first-charge market. I will explain why.
To achieve a sustainable market that works better for consumers we are going to need more responsible lending, with proper consideration of overall affordability and a reduction in the risk of the mortgage being inappropriate for the consumer.
We know the reason some consumers fall into arrears is because of the overall level of debt secured against their home, including second charges. In order to truly keep sight of affordability, responsible lending and overall indebtedness, we are asking whether we need to consider extending our regulation to these markets.
Some countries whose mortgage markets appear to have more successfully navigated the financial crisis have lending thresholds in place, limiting the amount a person can borrow through explicit caps on LTV or LTI. Some have suggested they could work well here.
Whilst we have an open mind on lending caps, I do believe personally that comprehensive and effective affordability measures have a key role to play. By that I mean measures that do more than look superficially at income and expenditure. And we know that for any lending thresholds to be an effective consumer protection measure, they need to have full consideration of the whole borrowing commitment to ensure there is no doubt as to whether a mortgage is sustainable in the long term.
But these measures, such as lending thresholds, affordability assessments and other measures to ensure responsible lending, can easily be circumvented if consumers have unrestrained access to alternative secured-credit borrowing.
So, as part of the review, we will consider whether FSA regulation should be extended to cover second charges. Because ensuring consumers are suitability protected – not over leveraged – might be better achieved if we had mortgage regulation covering first and second-charge mortgages on a consumer’s home.
I did note with particular interest the white paper the AFB published last year, looking at options for future regulation, which began a member consultation that came out in favour of second-charge lending by the FSA. It is not often we have firms asking to be regulated by us!
But I should make it clear that the decision on whether we will be able to regulate second charges is down to the government, who set the scope of our regulation.
So where does that leave us? The government has said it will keep the regulatory framework under review and is keeping in mind the forthcoming European directive, which is unlikely to distinguish between first and second-charge lending. We expect the imminent Discussion Paper from the government on financial services will give more detail on its thinking.
In the meantime, we continue to work with and support the work of the Office of Fair Trading (OFT), not least because there is much we can work on together in addressing responsible lending, affordability and the overlap of our responsibilities and interests in the mortgage market.
In summary, I can see clear benefits from the FSA seizing the opportunity to fundamentally review the mortgage market, so that when things pick up, we help shape an environment in which consumers can enjoy the benefits of a vibrant market without being exposed to unnecessary risks, with a stronger, more sustainable industry, with better controls of the risks involved in all mortgage lending.
Payment protection insurance
I would now like to offer the FSA’s perspective and approach to problems in the payment protection insurance (PPI) market. I know many of you are active in this market. As you are well aware, we have taken a keen interest in PPI since we began regulating the conduct of general insurance business in January 2005.
I can hear some of the audience yawning already, so it’s evident this issue has taken too long to resolve, but frankly it’s also abundantly clear that many providers and distributors knew long ago the issues that need to be resolved, but did little about it.
Let me say at the outset, we recognise that PPI can play an important and legitimate role for consumers, especially during these difficult times. But our regulatory focus has been and remains on how this product has been sold and whether consumers have been fairly treated when purchasing it.
The primary aims of our work are:
- to push firms to improve their sales standards;
- to limit consumer detriment from inappropriate sales and ensure consumer detriment is redressed; and
- to ensure that consumers are well informed and able to make better purchasing decisions.
In doing this, we have set out five outcomes we expect firms to deliver. They are:
- that firms should ensure their consumers are told that PPI is optional, where this is the case;
- that consumers are given clear information about the product and what it will cost;
- that consumers are given the assistance they need to be clear about what they are eligible for under the policy and what the main exclusions are;
- where advice is given, the consumer must be recommended a policy that meets their needs; and
- consumers must be offered a fair refund if they cancel their policy.
It is clear that this hasn’t always been the case. We have published 20 enforcement cases addressing PPI failings and requiring redress for consumers who suffered detriment. This includes one of our largest ever fines – £7m against Alliance & Leicester (A&L) last October.
The poor sales practices we have identified increase the risk of unacceptable outcomes for consumers purchasing PPI policies. We have found instances where a customer may be ineligible to make a claim on a policy they purchased and where they were not provided with adequate information to help them understand that, in single premium sales, they would be paying interest on their extra borrowing. Firms must do considerably better in order to ensure that consumers are not poorly treated.
It’s clear that the more complex single premium PPI sold with unsecured personal loansmarket sector was where most risk for consumer detriment arose. We indicated and endorsed the move by the market to withdraw that particular product. Let me stress again that we welcome a well sold, monthly variant that is inherently less complex PPI product.
And others have taken an interest too. We support the Competition Commission’s inquiry and the package of remedies it set out earlier this year, where it concluded that businesses that offer PPI alongside credit face little or no competition when selling PPI to their credit customers. We believe that they will deliver a positive improvement for consumers by offering a fairer and more competitive PPI market.
Our regulatory approach complements the work of the Commission. Our goal has always been to ensure that the combination of our work on sales conduct and the commission’s work on competition would lead to lasting improvements in consumer outcomes in PPI markets.
We will continue to work closely with the commission and with the OFT to ensure that our respective regulatory intervention and oversight is effective, proportionate and coherent.
Meanwhile, we will work with the industry to address any the remaining past selling issues and issue guidance on more effective complaint resolution shortly.
Close
So, in summary there is much still to do to ensure that consumers get the right outcomes when they are sold PPI. We will continue to take action where necessary and we encourage all firms to meet the standards we have set out.
And on the future regulation of your main line of business, the government is clearly thinking about whether to extend the scope of FSA’s regulation of mortgages. We are also considering this as part of our work on the mortgage market review, and you should expect action soon.
Finally, I recognise that many in society feel let down by the regulatory system and the regulator. At the FSA we have tried to be open and honest about the past shortcomings of the regulatory system. We have set out to lay the foundations of a more effective and better regime for the future. I believe we have made significant progress in extremely difficult conditions in pursuit of these goals. I also hope we have begun the process of rebuilding confidence in the system and the regulator by demonstrating we are an organisation that can learn and that we have the ability to change radically. It was that very clear commitment to change which encouraged me to join the FSA some nine months ago – I firmly believe the FSA will rise to the increasing challenges demanded by all.
But you all have a role to play in learning and acting upon lessons this crisis has burnt in all our memories. The impact has been very real and tangible on many in society and the real economy, and if we collectively don’t heed to the siren call for change, we will be failing the expectations of society.
Thank you.