The Bank for International Settlements revealed last week that it is gathering feedback on the mortgage insurance market in order to help policy makers reduce the risk of failure during a crisis.
The BIS’s consultation document, Mortgage insurance: market structure, underwriting cycle and policy implications, comes after an analysis of the global mortgage insurance market and warns the way the market has been approached in recent years means insurers are often positioned to fail precisely when they are most needed and greater regulatory powers may be required.
Mortgage Strategy exclusively revealed in last week’s issue that the Treasury had entered into discussions with lenders and trade bodies in order to explore how mortgage indemnity guarantees can be used to improve access to 95 per cent LTV properties.
The report says that because insurers are expected to bear the substantial brunt of a default, they will often be worse hit at times of crisis than the original lenders, severely diminishing their ability to provide an effective safety net.
The report says; “In the worst cases, failure of a mortgage insurer may occur leading to resolution of the insurer, whereby some of the most extreme tail risk may revert to the lender at the very time that the insurance would be most needed, potentially creating systemic risk.”
Conversely, standards can end up being relaxed further with the presence of an “extra pair of eyes” as the lender and insurer both assume each other are taking responsibility for oversight.
If the underwriters lower their underwriting standards while the lenders maintain high standards, this is unlikely to cause immediate problems, as the lenders’ standards would effectively protect the mortgage insurers from themselves.
However, under such circumstances, the lenders may begin to take advantage of the naïve insurance capital while weakening their previously high standards.
The report recommends policy makers should be granted greater regulatory powers, where needed, to ensure this imbalance does not occur.
“Where supervisors do not have the legal authority to do so, supervisory powers should be requested. Relevant policymakers should also ensure that supervisors have the appropriate legal authority to be able to make such verifications.”
The report recognises the role mortgage insurance – or mortgage indemnity guarantees – played in the major expansion of credit to the UK housing market which occurred in the late 1980s.
More credit was available as the abundance of insurance options reduced the incentives for banks to make appropriate lending decisions.
The report says: “The subsequent spike in mortgage possessions and arrears between 1989 and 1995 was seen by many as an inevitable consequence of this development.”