The Bank of England is scrutinising the terms under which mortgages are being granted to buy-to-let landlords as it decides whether to take action to cool the fast-growing market.
The Bank’s latest warning to landlords came in a list of risks to the financial system, as Threadneedle Street put banks on notice thatthey could be forced to hold a special capital cushion of up to £10bn to guard against any economic downturn.
On what analysts had dubbed “super Tuesday” for the banking sector, the Bank announced the results of its “stress tests” which found that Standard Chartered and bailed-out Royal Bank of Scotland had the weakest financial positions.
But in a shift in policy, Threadneedle Street said the banking system had moved out of the post-crisis phase and it was “actively considering” whether banks should start to put capital aside in anticipation of future downturns.
The Bank has been warning for many months that it is concerned about the buy-to-let mortgage market. While it did not take immediate action to cool this sector – in which lending has risen 10% in the first nine months of the year compared with 0.4% in owner-occupied properties – it said it was reviewing the lending criteria adopted by firms and stands “ready to take action”.
It said it was monitoring the effect of the extra 3% stamp duty announced last week by George Osborne in his autumn statement and provided a detailed analysis of the fallout on landlords from any interest rate rise. The Bank found that if mortgage rates were to increase by three percentage points, nearly 60% of buy-to-let customers could run into repayment difficulties while only 4% of homeowners would be likely to experience similar pain.
The announcement on bank capital was the first signal from Threadneedle Street that it could use new so-called countercyclical buffers in response to the 2008 banking crisis when banks ran down their capital before the economic downturn.
Banks could be ordered to make use of profitable periods to build up additional safety funds. The move could push up lending rates without a rise in the Bank’s 0.5% interest rate.
The Bank of England governor, Mark Carney, said: “In the process of increasing capital requirements there will be cost passed on to borrowers that will have an impact on demand and some impact on inflation.” But the Bank played down the impact as knocking 0.1 percentage points off GDP over three years and increasing the cost of bank funding for loans by 0.05 percentage points.
The Bank will announce in March whether it intends to put countercyclical buffers in place and each bank’s current capital will be assessed between now and then.
John Thanassoulis, professor of finance economics at Warwick Business School, said the move could “be in effect tightening monetary policy, which is not good for the UK with inflation so subdued”.
Shares in UK banks rose as Carney scotched lenders’ concerns that policymakers would keep increasing their demands for capital – which is now 10 times greater than before the crisis. Barclays, Lloyds Banking Group and RBS were among the 10 biggest risers on Tuesday.
The half-yearly assessment of risks to the system – which warned that the global economic environment was challenging – was published alongside heath checks on seven major lenders. The Bank said it was not concerned about the strength of the banking system, seven years on from the crisis.
“The global environment is unforgiving and the legacy of the crisis means private and public balance sheets remain stretched. This calls for resilience not fatalism. Today we have reaffirmed the strength of our banks in the face of these risks,” Carney said.
The Bank subjected seven major lenders to a hypothetical scenario that involved a dramatic slowdown in the Chinese economy, prolonged deflation, a reduction in interest rates to zero and a huge increase in costs for fines and legal bills of £40bn. The test found that profits would fall more than they had done during the 2008 banking crisis – by £100bn by the low point of the hypothetical scenario in 2016 – but capital cushions remained strong enough to withstand the downturn while increasing credit to the economy by 10%.
While RBS and Standard Chartered both passed the overall thresholds set by the Bank, they did not meet the policymakers’ judgment-based assessment of their capital strength. But neither was forced to change its plans as they had already taken steps to improve their financial position: RBS by selling businesses including Citizens in the US and Standard Chartered by embarking on a £3.3bn cash call.
The other lenders tested in the second annual assessment of financial health were HSBC, Barclays, Nationwide, Santander UK andLloyds.
Thanassoulissaid: “What the latest stress tests show is that we are out of the financial crisis – as all of the banks have passed – although two came close to not passing the test: Standard Chartered and Royal Bank of Scotland.”