Bank of England readies tools to tackle housing bubble

LONDON, March 27 (Reuters) - The Bank of England urged banks onThursday to consider the risk of future spikes in interest rateswhen they approve mortgages, and prepared tools to rein backpotentially dangerous lending.

British house prices have risen by around 10 percent overthe past year, and the central bank said mortgages were higheras a share of home-buyers' income than at any point since 2005.

From next month the body that regulates how British bankslend to consumers, the Financial Conduct Authority, willintroduce touger home loan underwriting standards.

The BoE said in a report of a quarterly meeting of its riskwatchdog, the Financial Policy Committee, that from June ithoped to have the power to set the interest rate scenarios thatlenders would have to consider when granting loans.

The central bank also said that when it conducts its part ofEuropean Union wide stress tests for banks this year, it wouldmake them consider the risk of a sharp rise in interest ratesand a big fall in house prices.

"The scenario was not intended to be the FPC's expectationof what would happen, but a coherent tail risk event againstwhich banks' resilience could be tested," the BoE said.

The FPC made no new formal recommendations, but it said thatconcern about financial markets' readiness for a rise ininterest rates was "now at the heart of the FPC's risk andvulnerability assessments".

This extended to emerging markets. While financial marketshad been little affected by turmoil in Ukraine and parts ofChina's financial markets, investors could have a false sense ofsecurity that interest rates will not return to more normallevels, the BoE said.

The BoE added that British banks' financial health hadimproved since its last report in November, but that uncertaintyabout the cost of past misconduct had increased.

Separately, the Bank published its terms of reference for anassessment of leverage ratios at banks, which it said wouldreport back in November. However it will not set a numericalvalue for a leverage ratio until later.

Under a global accord known as Basel III, banks across theworld must hold capital equivalent to at least 3 percent oftheir total assets on a non risk-weighted basis from the startof 2018.

The aim of the so-called leverage ratio is to serve as abackstop to a bank's core capital buffer, which is based onrisk-weighted assets.

Policymakers in Britain, Switzerland and the United Stateshave put more emphasis on the leverage ratio, saying banks cantoo easily game risk weightings in their core buffers. (Reporting by David Milliken and Huw Jones)