Regulators play down fears of banking crisis if house prices crash

Britain's financial regulators yesterday moved swiftly to dampen fears that the UK's banking system was vulnerable to a crash in the housing market.

The Bank of England and the Financial Services Authority (FSA) said the high street banks were "strong, well capitalised and profitable".

But the Bank said it was worried about rising levels of unsecured debts and repeated its warning that the longer the house-price boom continues, the higher the chances of a sharp slump in consumer spending.

Their comments followed a report by Standard & Poor's (S&P), the credit rating agency, which for the first time named the UK as a country facing potential stress in its banking system. It said banks were "vulnerable" to rising prices, mounting debt levels and the impact of the stock market crash on insurance companies and household wealth.

"The debt service burden of mortgage borrowers, even at the current low interest rates, is beginning to reach uncomfortably high levels, particularly with respect to those in the Greater London area," it said. "S&P is particularly concerned with the vulnerability of lenders to a hard landing in the rapidly expanding specialised mortgage market." The UK was ranked as a potential risk alongside the United States, Ireland, the Netherlands, Panama, Portugal and Spain. Countries "already under stress" included Brazil, China and Egypt.

But the Bank, which publishes its twice-yearly financial stability review today, played down fears the housing market could trigger a full-blown financial crisis. Alastair Clark, executive director for financial stability, said: "The UK banking sector remains strong and well capitalised. The flavour of the comments [from S&P] that it is in some sense shaky seems to us wide of the mark."

The FSA said the banking system was well capitalised and profitable. However, the Bank's stability review warned the recent accumulation of household debt was a major domestic risk. "Lenders who are, for example, more exposed to recent new borrowers with high loan-to-value (LTV) ratios might face a deterioration in the quality of their portfolio," it said.

The Bank is increasingly concerned by the level of unsecured borrowing, which is rising by 16 per cent a year, compared with 13 per cent for mortgage debt. Mr Clark said the Bank was monitoring it closely.

He said the models used by banks to grant loans – known as credit scoring – had been developed within a friendly economic environment. "It is possible that relationships embedded in credit scoring won't work quite as advertised in a period of economic weakness," he said.

Meanwhile, Stephen Nickell became the latest member of the Bank's monetary policy committee to enter the housing debate, saying fears of further price rises were not enough to stop it cutting interest rates. He said he voted for a rate cut in November because inflation was forecast to undershoot the target throughout 2004.

"I judged it was better to institute a small rate cut than hold off for fear of exacerbating problems of uncertain magnitude further into the future," he said.