BoE lender’s stress test comes amid ‘considerable’ cost of living concerns

The test will “assess the resilience of the UK banking system to deep simultaneous recessions in the UK and global economies, real income shocks as well as large falls in assets prices and higher global interest rates”, says Bowe in a speech to The Future of Financial Mutuals Research Workshop, Bayes Business School today.

She says the review comes at a time when the UK is experiencing “a considerable increase in the cost of living” driven by Russia’s invasion of Ukraine driving the price of food and energy higher, while restrictions of gas supplies to Europe begin to feed into household bills.

But she says households enter this period in better shape than they were at the beginning of the 2007 global financial crisis.

Bowe says the total stock of UK household debt was just under £2 trillion in the first quarter of this year, equivalent to around 124.5% of total household income.

She says: “Although high compared to historical standards, this is materially below its 2008 peak of 146%.”

The FPC member says these lower levels of debt were driven by deleveraging and by slower growth in new household lending following the financial crisis.

Over this period average annual household debt growth slowed from around 9% before the financial crisis to around 2.4% over the last decade. At the same time, annual income growth slowed by less, from an average of 4.6% prior to the financial crisis to 3%.

Bowe says: “So, households entered the pandemic period reasonably resilient and have been able to maintain a lot of this resilience.

“While lockdowns brought a sharp contraction in activity, they also led to a large rise in household savings. This coupled with extensive fiscal, monetary and lender support, through payment holidays, helped many households to bridge through.”

Commenting on the speech Building Societies Association chief executive Robin Fieth says: “As highlighted by Colette Bowe, the current rise in living costs and interest rates will put increasing pressure on UK household finances in the coming months, with some borrowers likely to struggle with bills and other spending commitments.

“Lenders provide tailored support to those who are struggling and will continue to do so.”

Bowe also defended the central bank’s decision to scrap its mortgage affordability test last month, which was welcomed by many in the industry, although some called the move unwise as cost-of-living pressures mount.

The FPC introduced the test in 2014, to “guard against a loosening in mortgage underwriting standards and a material increase in household indebtedness that could in turn amplify an economic downturn and so increase financial stability risks.”

The rule required lenders to apply a stress interest rate of 3% when assessing prospective borrowers’ mortgage affordability.

However, Bowe says the move was a “simplification of the regulatory framework”.

She says that the FPC’s existing loan-to-income limit, also introduced in 2014, which restricts the number of mortgages that can be extended to borrowers at LTI ratios at or greater than 4.5 times salary adequately safeguarded affordability.

Bowe adds that the defunct affordability test’s link to standard variable rates “introduced uncertainty about how the affordability test would behave, particularly as Bank rate moves.

We wanted to avoid the risk of rules being overly stringent, even though some concerns were raised during the consultation about the timing of withdrawing the test.”

The Building Societies Association Fieth adds: “The recent removal of the FPC’s affordability test was a welcome simplification of the regulatory framework which will reduce administration for mortgage lenders over time.

“Lenders must still assess affordability carefully and in line with expectations for interest rates, as required by the Financial Conduct Authority rules, and t. will be no free for all.”