Impact case study database

In 2003 Miles was appointed by Gordon Brown, then the Chancellor of the Exchequer to undertake a study of the UK mortgage market. Its purpose was to inform the regulations of housing finance. At any one time around 11 million households in the UK (comprising about half of the population) have a mortgage. The majority of people have a mortgage at some point in their life, and the way in which mortgage contracts are structured and how they are sold is central to their financial well-being. The Miles Review (see 3.1) was published in 2004. Its recommendations – particularly on the information provided to households about mortgages, on potential conflicts of interest between advisors and households, and on the risks of interest rate changes – influenced major changes in the regulation of mortgage sales and mortgage lenders. As a result of this research, Miles went on to serve as a member of the board of the Financial Services Authority (the body which oversaw the financial regulation of mortgage markets) and the Bank of England’s Monetary Policy Committee.

The changes in regulation culminated in the reforms introduced by the Mortgage Market Review in 2014. After that, stress testing of the borrower’s ability to deal with significant upwards adjustments in the level of interest rates – a key focus of the Miles Review – became part of the rules that govern mortgage sales. This affects around 1 million new mortgages every year in the UK. Lenders are now required to assess whether borrowers can continue to manage mortgage debt, should interest rates rise by three percentage points. This change has meant that lenders can no longer rely on borrowers having their incomes rise before there is any significant increase to interest rates. This change is particularly significant in the post 2008 landscape: which is marked by an unusually slow growth in household incomes. Despite this, and because of the reforms, mortgage defaults have remained at exceptionally low levels.

As explained by Lord Mervyn King (former Governor of the Bank of England) “ The Miles Review made several recommendations about how the risk of variable rate mortgages could be better shared among savers, lenders, and borrowers. They led directly to the decision by regulators that lenders must consider the affordability of a variable rate mortgage were interest rates to rise substantially” (see 5.1) . In addition to this, he writes, the review also “ led to changes that eliminated the cross-subsidisation of mortgages taken out by households of different risk characteristics. There are few examples of research that has such a direct impact on policy and the opportunities faced by large numbers of households” (see 5.1).

The effects of these changes are celebrated by Alex Brazier – current Executive Director for Financial Stability issues at the Bank of England, and member of the Financial Policy Committee – for having promoted economic and financial stability. He writes: “[Miles’s] work on the UK mortgage market, particularly his analysis of how new borrowers over-weight initial mortgage payments, contributed directly to the introduction by the Financial Policy Committee (FPC) of affordability stress tests for new mortgage borrowers in the UK and limits on high loan-to-income mortgage lending. These policies have limited any growth in the number of highly indebted households, promoting economic and financial stability” (see 5.4). Lord Gus O’Donnell – former Permanent Secretary to the Treasury, and Cabinet Secretary – echoes this sentiment when he writes: “[Miles’s] work on the mortgages market had a significant impact on thinking at the Treasury which eventually resulted in policy changes that, to this day, have improved the way the market operates. It is an excellent example of how serious economic analysis can lead to policy change” (see 5.2).

In 2009, Miles was appointed to the Bank of England’s Monetary Policy Committee. He served for 6 and a half years on this 9 person committee which was the decision-making body for UK monetary policy. The influence of its decisions on the mortgage market is direct and immediate. Miles’s landmark research on mortgages influenced how he and others on the committee made their decisions on interest rates and on quantitative easing – the policy whereby the committee decided to purchase around £300 billion of assets during the period when Miles was on the Committee.

With a similar mandate from the Governor of the Reserve Bank of India (then Prof. Raghuram Rajan), Ramadorai was asked in 2016 to report on the demand for, and provision of, financial services to Indian households. Ramadorai focused on many of the same questions for India that Miles had analysed for the UK. The Ramadorai Committee report (see 3.4) was publicly released in 2017 by the Reserve Bank of India, and revealed the challenges that Indians face in being able to participate efficiently in the formal financial system.

The report contains many recommendations (detailed in 5.8) to help households make better financial decisions. It incorporates an important sub-set dealing specifically with the mortgage market. These include: increasing incentives for first time homebuyers with mortgage tax deductions and, in particular, introducing requirements that all banks offering mortgage finance must do so by quoting rates relative to a single agreed standard national base rate. Linking these floating rates to a common benchmark simplifies, and makes more transparent, the relative rates charged by lenders. Prof. Viral Acharya – former Deputy Governor of the Reserve Bank of India – has said the following: the report “ informed several important policy decisions taken by the Reserve Bank of India and the Ministry of Finance […] It combined novel research conducted while Prof. Ramadorai was at Imperial College with significant practical policy recommendations. Of these, several have since been implemented, including the linking of mortgage rates quoted by banks to external benchmarks such as the central bank’s repo rate” (see 5.6).

As referenced above, and as a direct consequence of the report, the Reserve Bank of India now mandates that all new home loans are linked to the repo rate from October 1, 2019. This change is beginning to transform a market with over 50 million mortgage applications per year. It has already resulted in better customer outcomes in market, on account of improved transparency in the comparison process, meaning that customers are less likely to get into a mortgage that has uncompetitive terms. In addition, these changes have improved the monetary policy transmission mechanism in India since the linking to external benchmarks also directly connects household mortgage rates to changes in the monetary policy rate. Responding to the Ramadorai Report, Prof. Raghuram Rajan (former Governor of the Reserve Bank of India) has said: “ It is a serious, evidence-based contribution to policy thinking in Indian household finance… For example, the Reserve Bank of India has just mandated linking mortgage rates paid by households to external benchmarks such as the repo rate, aiding the effective transmission of monetary policy, and facilitating household product search in financial markets… [Ramadorai’s] research on this topic has had important practical implications for, and impact on, policy decisions in this context in India” (see 5.5).

The report has received massive national and international coverage in the financial and policy practitioner domains: over 51 articles and broadcasts in newspaper, radio, and television tier 1 Indian and international media. For a summary of the coverage see 5.9, which documents coverage around the release of the report.