The Bank of England has pledged to change the capital rules for challenger banks so that they can offer a more competitive mortgage service.
Following consultations with politicians and banks, the Prudential Regulation Authority (PRA) has said that it will rethink its approach to Pillar 2A capital, a rule regarding the add-ons of capital which individual banks must set aside above sector-wide minimums.
PRA supervisors will now take a more flexible approach to these capital requirements, particularly when it comes to mortgages.
This should reduce costs for challenger banks, and allow them to compete more equally on higher loan-to-value mortgages.
Sam Woods, the head of the PRA said: “This consultation is a major step forward for the PRA in facilitating effective competition, reducing capital requirements for eligible small firms. This will be good for competition and for safety and soundness.”
Meanwhile, Simon Kirby, economic secretary to the Treasury, welcomed the move as a “positive step in closing the gap between challengers and the big banks”.
The Pillar 2A issue has been criticised by newer lenders, who claim that it favours incumbent banks.
In order to calculate their Pillar 2A capital requirements, challenger banks have to use the regulators’ standardised models to calculate the riskiness of each loan they make.
However, since challenger banks only have a few years of data and operating experience behind them, the capital add-ons tend to be high.
Conversely, incumbent banks can use their own bespoke models, based on the historic performance of their loan portfolios, which usually work out a lot cheaper than the standardised models.
Some official estimates have found variations of up to 960 per cent for the same residential mortgage, between lenders using the standardised approach and banks using the bespoke models.
By relaxing the capital rules, it is hoped that challenger banks won’t feel pressurised into accepting higher-risk mortgages in order to keep their prices down.
“I think the new regulations are a good thing because challenger banks and new lenders are all offering something a little bit different,” said Daniel Bailey, principal at Middleton Finance.
“They definitely have their place. They offer a different angle on the mortgage market, and I think that a lot of the present lenders need to catch up with technology.
“I would welcome the new regulations if it gives more options to us brokers and our customers too.”
Challenger banks also welcomed the news, but warned that more needed to be done to improve competition in the market.
“The simple fact of the matter is that the mechanical application of the standardised approach leads to huge disparity in terms of the capital requirements,” said Paul Lynam, chief executive of challenger bank Secure Trust, adding that the proposals “do not go far enough, but they’re a step in the right direction”.
