By Grant Spencer*
Recent debate about rising house prices in Auckland and elsewhere has included discussion on the risk weights the Reserve Bank requires banks to apply to their housing lending. Some of this discussion has focused on the impact that risk weights may have on the volume of credit, and house prices.
Risk weights play an important part in the Reserve Bank’s supervision of the banking sector. They help to determine the amount of capital that the banks need to set aside to cover losses on their lending to different sectors. In essence, the riskier the sector, the more capital must be held against lending to that sector.
The risk weights factor in things like the borrower’s capacity to repay the money, the type of assets put up as security for the loan, and the amount of security relative to the size of the loan. History provides some insight into the importance of these various factors.
As a result of these risk factors, risk weights vary for different types of lending, with housing having a lower risk weighting than business or rural lending, which typically involve more risk.
The risk weights are not set in order to incentivise any particular lending type over another. Instead, they reflect the different risks inherent in different types of lending, leading to capital holdings against loans that are appropriate for the risks involved. This tends to result in higher lending margins on riskier loans, but does not imply that banks will always lend to housing ahead of other sectors. In principle, banks will set loan margins such that risk-adjusted returns will be similar across sectors.
The Reserve Bank sets its risk weights in accordance with the international standards set by the Basel Committee on Banking Supervision, adjusted to fit the New Zealand context.
Indeed, risk weights on housing lending in New Zealand are relatively high by international standards, the average in New Zealand being almost three times that of the Canadian average or around 1.5 times that of Australian or UK banks, according to a recent International Monetary Fund study. So the NZ regime does not favour housing lending compared to international norms.
The Basel Committee standards followed by the Reserve Bank provide for risk weights to be adjusted in accord with local risk factors, such as the position of the housing cycle. However, this facility is not designed to accommodate economic or social objectives. Rather it is intended for overall financial stability purposes – such as preventing an unusually large build-up of lending risk in a particular sector.
A build-up of lending risk can, in some circumstances, leave banks overexposed to a sector where an asset bubble develops and eventually bursts, threatening the stability of the financial system overall. Adjusting risk weights to account for these risks can help build greater resilience in the face of such bubbles and, used early, could help prevent bubbles developing in the first place.
Recently, regulators around the world have been developing macro-prudential tools, which include the potential adjustment of sectoral risk weights. It is one of a suite of macro-prudential tools the Reserve Bank has been assessing for potential use in the future, including in situations where house prices may be accelerating to unsustainable levels.
But adjusting sectoral risk weights in this manner is not for everyday use and should be used under very specific conditions. It may be the case that an alternative macro-prudential tool, such as Loan to Value Ratio (LVR) restrictions, could be more appropriate in any given set of circumstances.
The framework the Reserve Bank is currently developing will establish the parameters for using macro-prudential tools. This will include when and in what conditions they might be appropriate, as well as clarifying governance and accountability issues. A public consultation on macro-prudential policy is expected to be released in late March.
---------------------------------------------
Grant Spencer is the deputy governor of the Reserve Bank of New Zealand "and head of financial stability". This article is a copy of the one found here.
5 Comments
So the risk weights are not designed to accommodate economic and social objectives – so that explains housing unaffordability, childhood poverty, health issues, and much of the ills that are on the increase in NZ. But as long as financial objectives are met (no coincidence record bank profits) then ‘she’ll be right Grant.’ And NZers have to buy over inflated house prices at twice what is necessary, creating billions of dollars in bubble equity. But as long as financial objectives are meet. I would appreciate any feedback from interest.co.nz posters on what these financial objectives might be and how they do not seem to be aligned with the economic and social objectives of the average NZer.
Dale Smith outlines the fact that all Politicians past and present have failed to have an holistic approach to their legislative and policy making decisions. All Politicians regardless of whether they are at Local or Central Government have failed in delivering the objectives and the Public Servants of all the Government Agencies have also failed in this most basic fundamental obligation.
The Universal Declaration of Human Rights outlines the essential requirements for Economic, Social and Cultural objectives that are required yet all of our legislation contravenes the articles set forth within the Declaration. Those administering the various legislative frameworks then add to the problem by not acknowledging in their decision making processes the Articles within the Declaration.
All the people of NZ have themselves to blame here regardless of what your Political preferences are. Resolving the issues is not rocket science, it is not about fragments of legislation and Policy, Left, right or centre politics. Social, environmental, capitalist or other ideologies only exist to occupy people's minds from the real issues.
The institutionally educated and qualified barely have a functioning brain between them as they simply can't understand cause and affect.
What a non-article. He doesn't answer the question of the title:-
Grant Spencer explains why the regulator might adjust 'sectorial risk weights' when 'house prices may be accelerating to unsustainable levels.
And his conclusion is:-
"Adjusting sectoral risk weights in this manner is not for everyday use and should be used under very specific conditions".
I guess you'd have to have worked in a Government Department or University to understand how somebody with such limited thinking - like Grant Spencer, could get rise to the level of deputy RBNZ Govenor.
Now that we know everything is set in concrete ....surely the mechanics can be sorted by a computer programme and one single operator in a back office, in Westport. We no longer need the costly wasteful RBNZ with its WGTN office block...vault and bloated bureaucracy....savings to be had Tweak..come on...get moving...fire the lot.
This year is probably the last year in this cycle of house prices appreciation. Its not in New Zealand interest to push house prices any further. If you have children of your own then the cost of them getting on the housing ladder is more expensive, so its better to have low price appreciation. Secondly high house prices result in weak domestic demand ie weak retail, weak restaurant spending and lack of spending due to highly leveraged house holds. Thirdly this house price appreciation is built on lack of supply, historical low interest rates and Western Nation Money printing. When Europe, the USA print money and provide Cheap money to the rest of the world this creates bubbles. You can have a different bubble in a different part of the world. For example in Europe, USA stocks have risen substantly over the past year. Greece stock index have gone up more than 100%, China and Vietnam for example have overbuilt apartments and will take years to soak up. What we need to remember is that in 5 or 10 years time at some point there will be a hugh collapse of the financial system. I think first the USA dollar will have a currency crisis , massive depreciation, followed by a sovereign debt crisis. This could trigger the collapse. For 2013 if you are looking after the kiwi saver funds in this country then I would reduce equities by 50% and just put into cash as we will soon within the next 6 months have a noticeable correction of 20% which is overdue. The trigger will be poor corporate earnings or the USA fiscal cliff in May with taxes in 5 years time. Global interest rates are likely to rise regardless as inflation will kick in and oil prices are not going any lower.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.