LONDON Banks offering large home loans that risk fuelling a future housing boom will have to hold extra capital to keep the financial system safe, the Bank of England said on Monday.
Britain's weak economy makes a credit boom look a distant prospect for now, but the central bank and MPs are already putting in place new rules to stop lending destabilising the economy in future.
Prior to the crash, many British lenders offered mortgages covering almost all the value of the property, while in some cases borrowers were not required to provide evidence of their ability to replay the loans.
These practices catered for an almost obsessive demand by Britons to own their own homes.
The FPC stopped short of asking for powers to directly regulate how much of a deposit home buyers should put down, saying more debate was needed on this politically sensitive step.
Starting in April, the central bank's Financial Policy Committee will get broad powers to regulate how much credit is flowing into the economy and to clamp down on potentially destabilising hotspots in sectors such as property.
On Monday the FPC said more about how these powers would work in practice, and what warning signs it would look for before it orders banks to top up capital buffers so that they have enough reserves to mop up losses on soured loans in future.
The tougher rules might slow growth during a future credit expansion, the FPC said, but it insisted they would bring long-term benefits by reducing the chance of another financial crisis which could require taxpayers to shore up banks.
Britain's economy shrank more than 6 percent in a 2008-09 financial crisis and has yet to make up the lost ground, while its national debt has ballooned by tens of billions of pounds as a result of the cost of bank bailouts and a shrunken economy.
"If these tools are successful in reducing the likelihood and severity of financial crises, their use is likely to boost the expected level of UK GDP," the Bank of England said. "The best available studies point... towards only a modest negative impact on near-term growth if (capital rules) are tightened."
The impact on growth would be lessened by the fact that tighter credit conditions would bear down on inflation, allowing the BoE's Monetary Policy Committee to keep interest rates lower than they would be otherwise, the FPC said.
Britain's Council of Mortgage Lenders, a trade body for firms offering home loans, reacted cautiously to the announcement and said it would examine the plans to make sure they did not create any inadvertent barriers to home purchase.
The FPC is part of a wider shake-up of Britain's financial supervisory system which is being formally launched in April, when the committee's power to require banks to hold extra capital to cover specific sectors like property takes effect.
The power to force banks to top up their capital because of too much credit in general will not be available until a new European Union law on bank capital requirements comes into force. Negotiations on the law point to a 2014 start.
It may be some time before the FPC feels a need to tighten rules, however.
Current mortgage approval levels are far below those seen before the financial crisis unfolded in 2007-2008, and in August the BoE launched a Funding for Lending Scheme aimed at boosting lending to home-buyers and businesses.
Nonetheless, property booms and busts have been behind many of Britain's economic downturns in past decades, and policymakers have warned that it would be politically untenable for Britons to have to bail out their banks again.
The FPC set it would keep tabs on ratios of house prices and commercial property prices to rents, how large a deposit new borrowers needed as well as broader measures of how rapidly banks were increasing credit to other areas such as derivatives.
However Mat Oakley, director of commercial research at property broker Savills (SVS.L), said the FPC might not spot warning signs early enough if it looks mostly at indicators like property prices, rents and yields.
"It's going in the right direction, though... I don't think it will ever be possible to rule out a future property boom," Oakley said.
All banks, building societies and large investment firms who are based or operate subsidiaries in Britain will come under the FPC's scope, but some foreign bank branches will not be covered.
The FPC said it would monitor for "leakages" and recommend government action to close loopholes if needed. But EU law may limit Britain's ability to act in some cases. (Reporting by Huw Jones and David Milliken; Editing by Toby Chopra)