Bank of England warns it will go after firms looking to mask risks

By Jill Treanor

Some lenders are taking more risks and are seeking to ‘circumvent the spirit’ of the regulations, says deputy governor

The Bank of England deputy governor set out a number of products facing scrutiny from regulators, including an increase in mortgage terms from 25 to 35 years. Photograph: Martin Godwin for the Guardian

The Bank of England has issued a warning to major lenders not to repeat their antics of the years before the 2007 credit crisis when they deployed complex strategies to mask the financial risks they were running.

Sam Woods, one of the Bank’s deputy governors, also said some lenders were starting to take more risks and set out a number of products facing scrutiny from regulators, including an increase in mortgage terms from 25 to 35 years.


Referencing the famous phrase of William McChesney Martin, a chairman of the US Federal Reserve in the 1950s, Woods said the Bank is on alert for a “return to the punchbowl”.

“Across the wider market, we are observing – not from all firms, but definitely from a few– a shift in credit risk appetite as lenders compete with each other to find ways of widening the pool of available borrowers, increasing the size of loans available to them, or reducing the credit premium charged for inherently more risky loans,” he said.

Woods’s remarks were initially prepared for delivery in May to the Building Societies Association but delayed because of the purdah period imposed once the general election was called. They were published, in an updated form, on Monday.

In a warning to banks and building societies Woods said the Bank had already found behaviour from lenders that “might meet the letter of the regulation” but is “designed to circumvent the spirit”.

Banks would always innovate faster than the regulator could update its rules, he said. “However, some innovation is pure regulatory arbitrage – that is, action taken by firms to reduce specific regulatory requirements without any commensurate reduction in their risk,” said Woods.

“This is why we need well-informed rule-makers and alert supervisors, who together can smell when something is off and decide what to do about it,” Woods added.

“Firms ... should be prepared to defend their compliance, not only with the letter of the regulation, but also with our principles of prudence, effective risk management and adequacy of financial resources at all times.”

He outlined a number of practices that the regulator had uncovered, including borrowing that did not appear on banks’ balance sheets – through the use of so-called off-balance sheet vehicles. He also highlighted technicalities around the way banks handle assets that are easy to sell in a crisis – so-called liquid assets – and the way insurance products could be amended to bolster profits.

The 2007 credit crunch was characterised by an alphabet soup of acronyms for complex financial vehicles and products used by banks such as CDOs (collateralised debt obligations) and SIVs (structured investment vehicles).

With regards to lending, Woods’ remarks were published a week after the Bank of revealed it was stepped up its scrutiny of lenders providing finance on credit cards, personal loans and to buy cars.

Such lending is not typically conducted by building societies, which are more usually active in the mortgage market. Here, he said, the Bank had noted that mortgage terms were extending from 25 year to 35 years – or even longer. While that makes monthly repayments lower it means the total interest is higher, with final amounts due when the customer may have retired.

“That should not be a problem if lenders can be confident about the availability of such retirement income, or about the scope for the borrower to downsize and use the sale proceeds to pay off the balance of the loan,” he said.

He noted that building society profit margins were coming under pressure, often because they were keeping savings rates higher to keep members happy.

“Squeezed margins at building societies are exacerbated when pitted against the mutual pricing strategy many have adopted to protect members in an era of low rates – and so, building societies seek to source new lending that earns higher than average rates,” said Woods. “This combination of circumstances is what led a number of societies to broaden their lending appetites in the mid-2000s.”

More than 60 societies attended the BSA conference in 2004 compared with 44 this year. Societies “ought to be well aware of the warning signs, but I’m conscious that corporate memories can be shed surprisingly fast,” Woods said.

https://www.theguardian.com/business/2017/jul/10/bank-of-england-risk-lenders-sam-woods