PRA outlines plans to enhance competition in the mortgage market

The Prudential Regulation Authority (PRA) has outlined a range of potential measures aimed at helping mid-sized firms grow and compete more effectively in the residential mortgage market, and is inviting industry feedback on the best path forward.

The PRA has released a new discussion paper examining alternative approaches to calculating capital requirements for residential mortgage lending under the internal ratings based (IRB) framework.

The PRA says any amendments it decides to take forward "would represent less complex regulatory requirements for many firms, and should speed up the approval process compared with the current framework".

Currently, firms using the IRB approach model their capital requirements for their exposures to credit risk. This is in contrast to the 'standardised approach' which sets capital requirements for firms, and typically has higher average capital requirements for residential mortgages. 

The new discussion paper looks at two IRB components: ‘loss given default’ (i.e. how much money a lender expects to lose if the borrower does default) and ‘probability of default’ (i.e. how likely it is that a borrower will fail to repay a loan). Firms must estimate both to obtain IRB permission. 

For loss given default the PRA is considering a “foundation IRB approach”. This would allow firms to use PRA-prescribed values for loss given default instead of estimating their own. This would significantly reduce the amount of modelling, time and resourcing required to obtain IRB permission, making it easier for mid-sized firms to obtain it.

Questions asked around loss given default include which firms it should be available to, whether the approach should differentiate between buy-to-let and owner-occupied mortgages, and whether the PRA should look beyond residential mortgages and towards other retail exposures for this approach.

Firms would still need to model probability of default but the PRA is also considering amendments to address challenges faced by firms in estimating this. 

Earlier this month, the PRA announced a review into loan to income (LTI) ratio requirements. At present, mortgage lenders must ensure that no more than 15% of their new residential mortgages each year have an LTI ratio of 4.5 or higher. However, the Bank of England’s Financial Policy Committee (FPC) has asked the PRA and the FCA to reconsider how this limit is applied.

David Bailey, executive director for prudential policy at the PRA, said: “Mortgages are one of the most important financial products in the country and among the biggest decisions people make about their finances. The options set out in this discussion paper could have a positive impact on competition and growth whilst maintaining an appropriate level of resilience, and result in more people getting access to the finance they need to buy a new home.

“Once we have feedback to this discussion paper, we will look to take forward the best options to support effective competition among UK lenders.”