But starting from this elevated level, the risk that the FPC is concerned about is that with limited housing supply, the demand for housing in the UK continues to push prices up; that lenders are ever more willing to finance high loan-to-income mortgages as house prices rise, and that as a result household indebtedness climbs sharply, making the economy and financial system more vulnerable. This risk is greater at a time of exceptionally low interest rates which may well mask the likely true cost of a mortgage over time. So at its recent meeting the Financial Policy Committee agreed two measures. First, that when lenders are assessing applications for mortgages they test whether the mortgage would be affordable if interest rates were to be 3% higher. And second, that no more than 15% of a lender’s flow of new mortgages should be more than four-and-a-half times the borrower’s income. These measures do not bite now on the market as a whole. Most lenders are already testing whether borrowers could afford mortgages if interest rates were to rise by around 3%. The FPC’s first recommendation is intended to stop that from slipping. And though the proportion of new mortgages worth more than four and a half times the borrower’s income has been increasing sharply, it is currently around 10%, below the 15% limit the FPC has set in its second recommendation. These measures should be thought of as insurance.
Likewise, bringing the safety car in when the danger is passed will also have an impact. These can be difficult judgments to make. They need to be coordinated with the Monetary Policy Committee so that the latter can take them into account in steering demand in the economy as a whole. But the focus of the FPC is financial stability risk: ensuring the system is robust to stress and taking steps to make periods of stress less likely and less severe. That is its comparative advantage. I want to finish by setting out two recent examples of how the Committee approaches this task: first, the stress test of the major UK banks which is currently in train, and second, the action the FPC announced last week on the housing market. In April, the Bank of England launched a stress test of the 8 major UK lenders, as part of an EU wide exercise. Stress testing is one of the tools developed in the aftermath of the financial crisis to test the resilience of the financial system. In essence, a stress test sets out a so called “adverse scenario” in which the economy gets into trouble and financial risks materialize. Together with the banks, we can then look to see how they would cope with a scenario like this. Of course, supervisors in the UK have regularly stress-tested individual banks. But this is the first time that we will test all the major lenders at the same time.