RBNZ chooses 'speed limits' and 'tiered limits' to contain banks' high LVR loans rather than outright caps on high LVR lending

By Gareth Vaughan

The Reserve Bank is getting banks to break down their high loan-to-value (LVR) housing lending by borrower type as it outlines a preference for "speed limits" and "tiered limits" - as opposed to outright caps - in the LVR restriction tool included in its newly minted macro-prudential toolbox.

Last week's Budget included the release of a Memorandum of Understanding between Finance Minister Bill English and Reserve Bank Governor Graeme Wheeler. It clears the way for the central bank to use its so-called macro-prudential tools after consultation with the Finance Minister and Treasury, if it feels one or more of them is needed and chooses to use them, on a temporary basis to dampen "excessive" growth in credit and asset prices and "strengthen" the financial system.

The Reserve Bank has now issued a response to submissions on its macro-prudential policy consultation paper and another paper outlining its final policy position. The latter confirms a Reserve Bank preference for a watered down version of caps on residential mortgages with high LVRs - first reported by interest.co.nz when the Reserve Bank issued its latest Financial Stability Report earlier this month. At that time the Reserve Bank also revealed it's not keen on exempting first home buyers from any LVR restrictions nor on targeting LVR restrictions at regions, such as Auckland.

High LVR home loans are ones where the borrower has a deposit for a property purchase, or equity in the property, of less than 20% of the total value. The power to restrict high LVR lending by banks is one of the four new Reserve Bank tools. The country's big five banks have between 15% (BNZ) and 24% (ANZ and Westpac) of their residential mortgages by value at high LVRs.

However, the volume of high LVR residential mortgage lending has been increasing, highlighted by $1.4 billion, or 84%, of ASB's $1.7 billion growth over the past two quarters coming in lending where the borrower has deposit/equity worth less than 20% of the loan. Separately, the Reserve Bank recently moved to make the big four banks - ANZ, ASB, BNZ and Westpac - hold an average of 12% more capital against their housing loans to help cover potential losses. This adds up to about NZ$500 million between them, or an average of just NZ$125 million each.

This comes after Adam Hunt, the Financial Markets Authority's head of strategic intelligence, told interest.co.nz last month there's an Auckland residential property bubble, and people should spread their risk by holding some non-real estate assets.

Breakdown by borrower type on high risk lending

The Reserve Bank says it's getting a break-down of high-LVR housing lending from the banks by borrower type that it can use to help assess the pattern of high risk lending in the housing sector, and the regulatory impact of any high-LVR lending restrictions.

It says an outright limit on high LVR lending would mean banks wouldn't be able to undertake any high-LVR residential property lending above a given threshold. However, it says quantitative restrictions would typically take the form of "speed limits" restricting the share of new high LVR lending that banks can do, rather than outright limits. They could also take the form of outright limits on the proportion of the value of the residential property that can be borrowed.

"For example, zero new residential property lending permitted with an LVR above 90%. This can also be thought of as a speed limit of zero," the Reserve Bank says.

"A ‘speed limit’ would limit the share of new high-LVR lending to the residential property sector that can be undertaken above a given LVR threshold. For example, only 10% of new residential property lending might be permitted with an LVR above 90%."

"Tiered limits" may also be used.

"For example, only 10% of new residential property lending might be permitted with an LVR above 85%, only 5% of new residential property lending might be permitted with an LVR above 90%, and zero new residential property lending permitted with an LVR above 100%."

'Credit worthy borrowers'

The Reserve Bank says speed limits would let banks continue to provide some high-LVR loans to "credit worthy borrowers" such as individuals with low net worth but strong current or future debt servicing capacity. This speed limit option was "broadly preferred" in banks’ submissions.

"Speed limits would also reduce the incentives for disintermediation and avoidance, since banks would still be able to undertake some high LVR lending," the Reserve Bank says. "On balance, we believe the use of the ‘speed limit’ approach rather than outright caps on high-LVR lending would help to mitigate these costs by enabling banks to continue to undertake some high LVR lending to credit worthy borrowers."

"Banks have expressed a preference for this approach," the Reserve Bank adds.

It's also prepared to allow the limited use of exemptions.

"Exemptions will be permitted for high-LVR lending under Housing New Zealand’s Mortgage Insurance Scheme (MIS), including the Welcome Home Loan scheme and Kainga Whenua programme. MIS loans are intended to meet government housing policy objectives and present minimal risks to financial stability, as any bank losses are either underwritten or guaranteed by Housing New Zealand."

'We have no mandate to improve housing affordability'

 Meanwhile, the Reserve Bank says although broader government policy goals such as enhancing housing affordability are important, it doesn't have a mandate to pursue these. Rather, under the Reserve Bank of New Zealand Act 1989, macro-prudential tools must be used to promote financial system soundness and efficiency.

"We note however, that to the extent macro-prudential tools are successful in dampening excessive housing credit and house price cycles, they may indirectly contribute to such objectives, by helping to keep future house price growth more in line with economic fundamentals such as income growth."

 The Reserve Bank also says macro-prudential policy isn't intended to supplant measures designed to address fundamental balances between housing demand and supply.

"Freeing up land for subdivisions, reducing the time and cost of housing developments and improving productivity in the building sector are likely to be key in reducing house price pressures emanating from excess demand for housing. However, in the interim, macro-prudential policy may offer scope to make the financial system more resilient and help mitigate excesses in credit and asset price cycles that may flow from such imbalances," the Reserve Bank says.

It also notes that overall, macro-prudential tools – apart from LVR restrictions – may only have a "weak" impact on dampening an overheating credit cycle.

"However, it bears emphasising that the primary purpose of such tools is expected to be to build additional resilience in the banking system rather than exerting a strong dampening effect on credit supply and demand."

The other three macro-prudential tools in the Reserve Bank's toolbox are;

*Adjustments to the Core Funding Ratio - altering the amount of equity, retail funds and longer-term wholesale funding banks have to hold.

*A Countercyclical Capital Buffer - effectively banks holding more capital during credit booms.

*Adjustments to sectoral capital requirements - increasing the amount of capital banks must hold in response to sector-specific risks.

See all our stories on macro-prudential tools here.

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