RBNZ Governor says new LVR limit will be set at just 10% of a new bank's loan book from October 1

Reserve Bank Governor Graeme Wheeler says that from October 1 banks will be subject to restrictions on high loan-to-value ratio (LVR) housing mortgage loans.

Banks will be required to restrict new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new housing lending flows.

Due to some exemptions the effective figure is expected to be about 15%. In recent months banks have been doing about 30% of their lending in high LVR loans. 

But the setting of such a relatively low figure - the 10% is lower than the RBNZ gave in examples of how the limits might work - is likely to come as a shock to the big banks. Many of the banks have already been sceptical about how the LVR limits might work.

Wheeler said that how long the LVR restrictions may remain in place "depends on the effectiveness of the measures in restraining the growth in housing lending and house price inflation".

"LVR limits will be removed if there is evidence of a better balance in the housing market and we are confident that their removal would not lead to a resurgence of housing credit and demand," he said.

"If the measures are not considered to be effective (and cannot be made effective through altering the details of the policy) they will be removed, but in this case their removal might necessitate higher interest rates than otherwise, or the imposition of alternative macro-prudential requirements."

In fact the speech was at Otago University.

Wheeler said some loans would not count towards the banks’ use of the speed limit.

These included Housing New Zealand’s Welcome Home Loans, bridging loans, refinancing of existing loans and high–LVR loans to existing borrowers who are moving home but not increasing their loan amount.

Allowing for these exemptions, the RBNZ estimated that the 10% speed limit would effectively limit the banks’ high-LVR lending flows to about 15% of their new residential lending.

Banks respond

The industry body for the banks, the New Zealand Bankers’ Association said banks would continue to "work hard to meet their customers’ needs" within the new restrictions - but it warned of some adverse consequences.

"People should be aware they may be declined loans because of the new restrictions imposed by the Reserve Bank. It’s worth talking to your bank about your individual needs and circumstances," chief executive Kirk Hope said.

“Most small New Zealand businesses raise investment capital through equity in their homes. LVR caps may limit their ability to invest in their businesses. The lending limits may also make it more difficult for first-home buyers and home-owners seeking a top-up loan for renovations," Hope said.

"The real issue is a lack of housing supply in some parts of the country, not the availability of cheap credit," he said

"...Credit growth, currently at around 5%, is not driving this."

ASB chief economist Nick Tuffley said the ASB expected the new restrictions "will slow housing market activity over the coming months, although the effects are likely to be modest".

"However, given the persistence of supply and demand imbalances we continue to expect house prices will continue to increase over the next couple of years.

"In early 2014 the inflation outlook will also increasingly point to interest rate increases.  However, on balance we see recent market pricing of a 3.75% OCR by the end of 2014 as a little on the high side," he said.

Westpac senior market strategist Imre Speizer said the timing of the RBNZ announcement may have surprised the market, "which may have been expecting a background discussion rather than an explicit introduction".

"Interest rate markets reacted sharply, the 2-year falling from 3.55% to 3.45%, and the 2-10-year curve steepening slightly  further from 152 basis points to 154bp. The NZD/USD exchange rate fell from 0.8025 to 0.7980, while AUD/NZD rose from 1.1320 to 1.1380," he said.

"An additional reason for the market reaction may be a deeper reflection of the impact on the OCR outlook. The RBNZ will need time to assess whether this measure will slow the housing market, and it is arguable whether that assessment could be completed before January 2014 (markets previously priced in a March 2014 hike which would need to be signalled by the January meeting).

"The market may therefore push out its pricing for OCR hikes." Speizer expected the LVR limits would have "limited" effectiveness in cooling the housing market. 

ANZ chief economist Cameron Bagrie and senior economist Mark Smith said they expected the LVR restrictions to "dampen demand but to be no silver bullet for Auckland’s housing woes".

"They do give the RBNZ more wiggle room."

Bagrie and Smith said there was speculation of "a mad rush of pre-approvals" for mortgages over the six weeks before LVR implementation.

"We don’t think this will be the case: the RBNZ has stated they expect banks to start modifying their approach today.

"Anecdotally, financial intermediaries have already been backing off in the high-LVR space and we expect this to continue. The loan approval process will be tightened to hit the desired speed limit."

BNZ senior economist Craig Ebert said, on how long the LVR limits may be in place, "practically speaking, we must be talking of at least until the end of March 2014, given it’s a six-month period that will be used to judge the 10% ratio initially, before shifting to a 3-month rolling basis after that".

A number of months would also seem necessary before the RBNZ could reasonably expect to discern the impact of the LVR restriction (on cooling the housing market)," he said.

"This runs the risk of the Bank fiddling while Rome (read: the housing market) burns." 

To be fair, the RBNZ was not blind to these risks, as exampled by its comment that it would remove the LVR limits if they could not be made effective but would then possibly have to put interest rates up higher than would have been otherwise the case. or use alternative "macro-prudential tools", Ebert said.

"Still, to the extent orthodox tightening should be the preferred, and more powerful, tool, by the time this is realised it would probably have to involve some aggressive catching up on this front."

Kiwibank's promising to put first home buyers first in the lending queue.

"When it comes to lending with deposits of less than 20%, we will give priority to first home buyers over those who are buying investment properties," chief executive Paul Brock said.

Wheeler concerned

Wheeler said the RBNZ was concerned about the rate at which house prices were increasing "and the potential risks this poses to the financial system and the broader economy".

"Rapidly increasing house prices increase the likelihood and the potential impact of a significant fall in house prices at some point in the future. This is particularly the case in a market that is already widely considered to be over-valued s concerned," Wheeler said.

The LVR restrictions were designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy.

“However, while higher policy rates may well be needed next year, as expanding domestic demand starts to generate overall inflation pressures, this is not the case at present. CPI inflation currently remains below our 1% to 3% inflation target.

"Furthermore, with policy rates remaining very low in the major economies, and falling in Australia, any OCR increases in the near term would risk causing the New Zealand dollar to appreciate sharply, putting further pressure on New Zealand’s export and import competing industries," Wheeler said.

Best response

In the current situation, where escalating house prices are presenting a threat to financial stability but not yet to general inflation, macro-prudential policy "offers the most appropriate response" he said.

Wheeler said house prices were high by international standards when compared to household disposable income and rents. Household debt, at 145 percent of household income, was also high and, despite dipping during the recession, the percentage was rising again.

"Furthermore, the growth in house prices is occurring after only a small correction following the house price boom of 2003-2007 that saw New Zealand house prices increase more rapidly than in any other OECD country."

Wheeler said the RBNZ was not alone in expressing concerns.

"Over the past several months the IMF, OECD, and the three major international rating agencies have pointed to the economic and financial stability risks associated with New Zealand’s inflated housing market."

The RBNZ considered that LVR speed limits would be more effective than other "macro-prudential tools" in constraining private sector credit growth in the housing sector, and dampening housing demand, Wheeler said.

Other macro-prudential instruments, such as counter-cyclical capital buffers and capital overlays on sectoral capital requirements, were likely to have less effect on the demand for housing-related credit and on house price growth.

Abide by the spirit

He reiterated earlier RBNZ sentiment that it was expecting the banks - who will have the LVRs as part of their conditions of retaining registration as a bank - to abide by the "spirit" of the new rules.

“We are concerned to ensure that specially designed lending products are not developed with the purpose of avoiding or undermining the LVR restrictions. The Reserve Bank expects bank senior management and bank boards to respect the spirit and intent of the LVR restrictions and to closely monitor the level of high LVR lending."

Wheeler said it was critical that priority be given to implementing measures needed to relieve the shortage of housing and land supply, "which is the dominant cause of the increase in house prices in Auckland and Christchurch".

"But the LVR restrictions have a useful role to play alongside the supply measures."

The background

The RBNZ's announcement today has been well sign-posted.

It gave more details of its plans last week. Although LVR limits are in theory something aimed to achieve financial stability, the RBNZ has indicated previously it sees them as being able to take heat out of the housing market. While the latest monthly real estate figures showed some easing in price pressure, there is no doubt the overall state of the market could fuel future inflationary pressures.

In the meantime, the Government has been attempting to ease the path of first home buyers into the housing market, having earlier failed in attempts to get first-timers exempted from the RBNZ moves. See here for articles about LVRs. See here for articles on the RBNZ's macro-prudential tools.

The move has already prompted criticism from among banks. Last week BNZ's head of research Stephen Toplis said in his  "Economy Watch", that the LVR move was a "gamble" designed to slow down the pace of house price inflation in order to reduce the banking sector’s vulnerability to a future house price correction. He also talked about the RBNZ being in "panic mode" about house price inflation. And he argued that the central bank was sending conflicting signals and says its credibility is on the line.

The measures have been some time coming. After a memorandum of understanding was signed between the Reserve Bank and Finance Minister Bill English in May paving the way for the macro-prudential tools, Wheeler said the tools could be used to build additional resilience in the financial system during periods of rapid credit growth and rising leverage or abundant liquidity.

They would also dampen excessive growth in credit and asset prices, he said.

“These new tools could be used from time to time to help avoid extremes in credit and asset price cycles. They can promote financial stability by helping to build capital buffers and reduce incentives for speculative behaviour, which can contribute to boom-bust cycles in credit and asset prices," said Wheeler.

The four macro-prudential tools, which could only be applied to registered banks on a temporary basis and wouldn't affect existing loan agreements, are:

• the countercyclical capital buffer, effectively banks holding more capital during credit booms;
• adjustments to the minimum core funding ratio, altering the amount of retail funds and longer-term wholesale funding banks have to hold;
• sectoral capital requirements, or increasing bank capital in response to sector-specific risks;
• restrictions on high LVR residential mortgage lending.

The Reserve Bank has said it could implement more than one tool at a time.