Relaxed lending criteria will not necessarily result in higher mortgage volume, but lenders could use it as an opportunity to maintain or improve market share, a credit rating agency said.
Analysing the impact of looser mortgage rules in Europe, Moody’s said that after a decade of gradual tightening, six of the eight European countries with high household debt levels had seen a loosening of rules.
Moody’s said lenders typically reacted by sticking to their own risk appetite and lending strategies, which were influenced by other factors.
Further, in more competitive markets, lenders use looser mortgage rules to “maintain or improve their market share” with the “incremental loosening of underwriting criteria.”
In the UK, Moody’s said this resulted in challenger banks targeting high-risk borrowers as high street banks capture their typical customer base.
Additionally, the firm said Basel 3.1 reforms, which were implemented in the EU in January and delayed in the UK until 2026, incentivised banks to lend at lower loan to values (LTVs).
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For example, under the standardised Basel 3.1 approach, banks require twice as much capital to lend at 90% LTV than at 55% LTV.
Increase in defaults and mortgage losses
The firm said that, so far, the easing of lending over the last decade had been modest and supported house prices, but in the long term, this could raise the risk of defaults and mortgage losses.
It said looser mortgage rules were “therefore credit-negative for mortgage holders including lenders, covered bonds, and residential mortgage-backed securities (RMBSs)”.
Its report referred to the UK removing the 3% additional stress rate for mortgage lending and said this had not affected arrears levels but could lead to weaker performance in the future.
Although banks have tightened underwriting criteria since the global financial crisis, Moody’s suggested that the loosening of regulatory standards now would “likely lead to a deterioration in the credit characteristics of new mortgage loans, and consequently higher non-performing loan (NPL) levels in a future housing downturn”.
It also said borrowers with high debt-to-income ratios were “particularly vulnerable” to the negative effects of eased lending rules because they were less able to service additional debt.
Additionally, relaxed lending rules could limit lenders’ ability to support borrowers in countries with high levels of household debt.
Looser lending rules stimulate house prices
In countries with high demand for housing, limited supply or “malfunctioning” rental markets, higher mortgage volume created by looser lending rules drove up house prices, Moody’s said.
It also said the negative impact of loosened lending rules would be most pronounced in countries where a large share of homes are mortgaged.
Homeownership rates in the UK were around 65%, lower than the European average of around 80%.
Moody’s said that, along with the Netherlands and Denmark, household indebtedness in the UK had “significantly decreased” since the peak at the time of the global financial crisis.
Banks able to absorb shocks
The firm said strong labour markets had been the primary driver behind strong mortgage performance, citing the UK’s unemployment rate of around 4%. However, in countries with higher unemployment rates, Moody’s found this did not translate into higher NPL levels because mortgage borrowers were less affected by increased unemployment, which disproportionately impacted lower-income workers who did not qualify for a mortgage.
Banks are also more equipped to absorb shocks, such as a rise in arrears, than before the global financial crisis, so looser lending rules causing a rise in mortgage originations could support banks’ revenues and improve their ability to absorb losses.
Moody’s said this would offset the negative impact of relaxed lending rules.
This month, Chancellor Rachel Reeves wrote to regulators asking them to consider easing mortgage rules to support growth. In response, Nikhil Rathi, chief executive of the Financial Conduct Authority (FCA), requested political guidance, saying relaxed criteria could cause a rise in defaults.
