Easing mortgage lending rules in the UK, which is made up of households heavily in debt, would push up default risks and “constrain” the ability of regulators to calm any following disruption, according to Moody’s.
The UK is one of several European countries with high household debt that has loosened home loan lending rules in recent years and is considering further steps, which may lead to significant rise in mortgage defaults.
“After a decade of gradual tightening, regulators are loosening mortgage underwriting rules in six of the eight European countries with the highest household debt levels, writes Moody’s vice president, senior credit officer Alexander Zeidler.
“This loosening increases long-term risk for residential mortgage-backed securities, covered bonds, banks and other mortgage holders.”
The nations singled out are Norway, Switzerland, Luxembourg, Sweden Finland and the UK, which has a debt-to-income of 120%, according to third-quarter Office for National Statistics data.
Moody’s adds: “In these countries, borrowers generally have less capacity to service additional debt, and relaxed lending standards can constrain regulator’s ability to ease conditions during future periods of market stress.”
The note comes after last week Financial Conduct Authority chief executive Nikhil Rathi called on the government to lay out a level of mortgage defaults that are acceptable if it relaxes lending rules.
Rathi told a House of Lords financial regulation committee, “more relaxed lending would lead to more defaults” as well as growth.
He added: “We need to have a conversation about the risk appetite of parliament.”
The plea from the City watchdog came after Prime Minister Keir Starmer and Chancellor Rachel Reeves wrote to regulators in December calling on them to ease red tape to allow the UK economy to escape its persistent low growth.
The Financial Policy Committee withdrew a mortgage affordability test in 2022, but left in place its key guideline that banks should not lend more than 15% of their homeloan books at more than 4.5 times loan-to-income. Both tests were introduced in 2014.
Many banks and brokers say keeping this more than decade-old rule in place bars borrowers who could comfortably afford a mortgage from entering the market.
Moody’s note says: “Relaxed lending limits do not necessarily lead to increased mortgage volume, because banks set underwriting criteria according to their own risk appetites and their lending strategies are influenced by many factors.”
However, the credit agency adds that the characteristics of national markets can lead to keen lending terms.
It points out: “In some countries, as the main lenders have sought to grow their lending base, smaller lenders have had to adapt, with incremental loosening of underwriting criteria.
“For example, in the UK, challenger banks sometimes target high-risk borrowers when High Street banks encroach on their typical customer base.
“The relaxation of underwriting standards in the UK has not affected current arrears levels so far, but could lead to weaker performance in the long term.”
However, the credit agency argues that the strong UK labour market and low unemployment will mitigate the risk of a downturn.
It adds: “The credit quality of banks is more robust today than it was before the 2008 financial crisis, and banks are better equipped to absorb shocks such as weaker mortgage performance, should arrears increase.”
