New Zealand Reserve Bank announces restrictions on mortgage lending for borrowers with less than a 20% deposit

Concerns at the rate of New Zealand house prices growth - and the potential risks that posed to the financial system - has prompted the NZ Reserve Bank to impose restrictions on the loan-to-value ratio (LVR) housing mortgage loans within lending banks from October 1.

The announcement has been described as harsher than the 12% "speed limit" that the RBA privately foreshadowed in June.

"Housing plays a critical role in our economy," the governor Graeme Wheeler said in a speech today.

"It represents almost three quarters of household assets and mortgage credit accounts for over half of banking system lending.

"Consequently, housing is a major source of value and of risk to the household sector and the banking system.

"The Reserve Bank focuses on the housing market for three main reasons.

"First, housing and the construction sector can be a source of inflationary pressure if construction costs and rents increase and the ‘wealth effects’ of rising house prices feed through into additional spending or borrowing to finance consumer goods. Second, the possibility of a significant fall in house prices can have important implications for financial stability and on the ability and willingness of banks to lend to support a recovery.

"Finally, declining house prices can have significant impacts on output and employment, especially when the associated de-leveraging of household and corporate balance sheets continues for several years."

The governor said at present, rising construction costs were not a major concern for monetary policy.

Construction costs in Christchurch are up 12% over the past year and recently rising in Auckland with changes in relative prices needed to attract additional workers and resources into the construction sector.

"Our main concern is the rate at which house prices are 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."

Mr Wheeler said the NZ Reserve Bank 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.

"In April this year, the IMF suggested that New Zealand house prices were over-valued by around 25 percent, and the OECD has expressed similar views.

House prices increased by 16% and 10% respectively in Auckland and Christchurch over the past year (three-month moving average to July 2013 over the same period in 2012).

They increased by 4% over the rest of New Zealand overall, with considerable variability among regions.

Its house prices are high by international standards when compared to household disposable income and rents.

Household debt, at 145%  of household income, is also high and, despite dipping during the recession, the percentage is rising again.

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

"Rising house prices in Auckland and Christchurch are mainly a result of supply shortages, although demand-side pressures are also a factor due to pent up demand, the lowest mortgage rates in 50 years, and aggressive competition among banks for new borrowers, including borrowers with low deposits.

"Auckland’s Council suggests that Auckland’s current housing shortage is 20,000 - 30,000 houses with 13,000 houses needing to be built each year to meet future demand. Christchurch’s shortfall is around 10,000 houses. Strikingly, for a city with geographical boundaries equivalent in size to Greater London, and a population of 1.5 million (a sixth of Greater London), Auckland has only produced an average of 4300 new houses annually over the past three years.

Initiatives such as the Auckland Accord, and measures to increase the availability of land zoned for residential housing, and to raise productivity and lower costs in the building sector, are important for increasing housing supply.

"However, it is likely to take considerable time for the supply/demand imbalance in the housing market to correct through supply-side measures alone. In the absence of demand measures, house prices might continue to rise rapidly and pose an increasing risk to financial stability."

Mr Wheeler said the conventional mechanism to help restrain housing demand while working on the supply response would be to raise the official cash rate (OCR), which would feed through directly into higher mortgage rates.

"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.

"Consumer Price Index (CPI) inflation currently remains below our 1 to 3 percent 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.

"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.

"One of the major insights from the Global Financial Crisis (GFC) was how rapidly macro instability could develop even though an economy might be growing close to its potential, and be experiencing sound fiscal policy and price stability.

"Economic and financial risks can build up for several reasons, including over-investment in particular sectors such as housing, a rapid increase in leverage in the banking and shadow banking sectors, and excessive household indebtedness.

"The output losses and increased human distress from the massive adjustments in the balance sheets of households, corporates, banks, and governments are still being felt in many countries five years after the initial impact of the GFC.

"The fallout from the GFC triggered a renewed interest in macro-prudential policy in several countries.

"While micro-prudential policy settings (e.g., capital ratios and risk weights) are fixed on a through-the-cycle basis, macro-prudential policy measures provide an overlay to mitigate significant but transitory risks (such as credit and asset price cycles) that can endanger the economy and the financial system."

In May 2013, the Minister of Finance and the Reserve Bank signed a memorandum of understanding outlining the purpose of macro-prudential policy, the range of policy instruments, and governance arrangements relating to their possible deployment.

The macro-prudential policy framework seeks to build additional resilience in the domestic financial system during periods of rapid credit growth, rising leverage, or abundant liquidity.

The instruments can also help to dampen growth in asset prices that pose risks to financial stability.

The macro-prudential measures may require banks to hold additional capital buffers, have higher proportions of stable funding, or limit the share of high loan-to-value ratio (LVR) residential lending.

Instruments such as the counter-cyclical capital buffer and sectoral capital overlays require banks to hold additional capital against potential shocks in asset markets or particular sectors. A temporary increase in the core funding ratio would make banks more resilient to liquidity shocks and, like capital buffers, serve mainly to increase the resilience of bank balance sheets rather than have a significant dampening effect on asset cycles.

LVR restrictions have the added benefit of dampening asset prices more directly, by affecting the supply and cost of high LVR lending as well as reducing the riskiness of bank loan portfolios.

"High LVR lending, as reflected in mortgage lending to borrowers with less than a 20% deposit, has constituted around 30% of new mortgage lending in recent months – up from 23% in late 2011," Mr Wheeler said.

"This high LVR lending is a significant factor behind the buoyant housing demand in some regions.

"Today we are announcing the introduction of speed limits on high LVR lending with an implementation date of 1 October 2013.

"These are 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.

"Under the LVR ‘speed limit’, 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.

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

"LVR restrictions will support monetary policy.

"While the primary purpose of the restrictions is financial stability, they will also provide the Reserve Bank with more degrees of freedom in conducting monetary policy.

"In particular, they will provide the Bank with greater flexibility in considering the timing and magnitude of any future increases in the OCR."