Supervisory Diamond for mortgage banks

Today the Danish Financial Supervisory Authority published a proposal for a Supervisory Diamond for mortgage banks. It is a welcome initiative to establish a Supervisory Diamond for the mortgage credit sector alongside the existing Supervisory Diamond for banks. The corners of the diamond for mortgage banks are focused on mortgage banks' credit risk on lending and access to the necessary funding. Specifically, the diamond relates to lending growth, borrowers' interest-rate risk, deferred amortisation, short-term funded loans and large exposures. All of these areas may give rise to elevated risk. The diamond corners are supervisory elements intended as an early warning system if a mortgage bank is assuming excessive risk.
 
On the other hand, the Supervisory Diamond is not suitable for limiting the use of deferred amortisation by individual households. The mortgage banks have granted deferred amortisation loans to many households right up to the loan-to-value limit of 80 per cent. This makes the households vulnerable to even minor declines in property prices, and for the mortgage banks it entails a risk of having to fund top-up collateral for the bonds. A decisive aspect of the mortgage system is to preserve bond security and to ensure that the system remains robust also in periods of falling house prices.
 
Danmarks Nationalbank recommends supplementing the Supervisory Diamond with legislation on lower loan-to-value limits for deferred amortisation loans – as a ratio of the property value at the time of granting the loan. This should apply to deferred amortisation loans underlying the issuance of covered bonds, covered mortgage bonds and mortgage bonds by banks and mortgage banks. Hence, over time borrowers will automatically build up a certain distance to the loan-to-value limits, which will further emphasise the high degree of security in the mortgage credit system, even in the event of substantial drops in house prices.​