Regulation has been put in place to curtail banks’ ability to take excessive risk and to rely on short-term wholesale funding. 8  See Mcleay and Thomas (2016 forthcoming). 9  Changes in capital regulation may also have had an impact on mortgage lending spreads. BIS central bankers’ speeches  5  Debt servicing Another lens through which we can look at the sustainability of the increases in debt and asset prices during the upswing of the last financial cycle is the debt servicing ratio or “income gearing”. The aggregate household debt service ratio in the UK rose to 13% in 2007 but is now at its 2001 level of around 8% (Chart 6).10 That is a little below its historic average since 1988. But while the ratio is back at 2001 levels, its composition is now very different. In 2001, the debt stock was around £ billion and the interest rate was 6.7%. Today it is over £ trillion and the rate has fallen to 3.6%. These debt service numbers do not include consumer finance which add to the household debt stock. The stock is small relative to secured lending, at around 10–15% of the stock of secured lending. But it is growing quickly at around 9% per year. High levels of consumer finance tend to be associated with households that have high overall debt service levels.
On the other hand, some of the factors which affect preferences for desired saving and investment (demographics and the income distribution, for example), are likely to lift the sustainable level of debt and asset prices. Credit spreads and credit supply The interest rate charged to borrowers and by which risky assets are valued reflects more than just the risk free rate. It includes the spread above the risk free rate charged by the lender to reflect the costs and risk of lending. If reductions in the spread above the risk free interest rate are long lasting, they too will raise both the sustainable level of debt relative to income and the sustainable level of asset prices. In the run up to the recent crisis, the spread over the risk free rate fell. For example, lending spreads on new UK mortgage lending fell from around 100bps in around 2000 to a low of around 30bps in 2007. More generally, shifts in credit supply may occur through increased bank competition over nonprice factors (such as increasing the availability of credit to borrowers with high LTIs and LTVs), or because of regulatory and other policy changes that affect banks’ ability to lend. These shifts in credit supply may appear as direct increases in the credit to GDP ratio but show up less obviously in lending rates. Such shifts may show up as increases in deposit rates rather than falls in lending rates if they affect competition for retail and wholesale funds.