The Reserve Bank published a consultation paper yesterday seeking feedback on serviceability restrictions such as debt:income (DTI) limits on loans being added to its macro-prudential toolkit.
The notion immediately drew fire, but the bank said it wanted feedback from stakeholders on alternatives as well. The 3 questions:
- the risks posed by high debt:income lending and the potential for a debt:income limit or similar policy to ameliorate these risks
- alternative policies under the Reserve Bank’s control and how they would compare to a debt:income limit, and
- desirable design features for any debt:income policy and the potential costs & benefits.
The bank has outlined its views on these issues in the consultation and said it wouldn’t implement a debt:income policy in current market conditions, but that it considered debt:income limits could be a useful option in the future.
The consultation paper includes a cost:benefit analysis for a debt:income policy and found there could be significant net benefits.
Feedback closes with the bank on Friday 18 August.
Property Institute warning
Property Institute chief executive Ashley Church repeated his warning that such limits on mortgage lending “would have the potential to do significant damage to the Auckland housing market & the wider New Zealand economy”.
Mr Church said a similar policy introduced in the UK in July 2014 theoretically restricted a buyer to a mortgage that didn’t exceed 4.5 times their annual earnings, but it wasn’t compulsory for banks to impose it and it only applied to a section of the market: “The Brits wisely chose to use this tool as a way to protect those who were at most risk of a market crash rather than as a blunt tool to curb house price inflation. But our Reserve Bank already has that ability in the form of the LVR restrictions – so you’d have to question why they would want this tool unless they want to kill the market – something they’ve repeatedly tried, and failed, to do.”
Mr Church says the probable consequences of such a policy would be disastrous: “The number of new homes being built – the very thing that Auckland needs most – would plunge as the number of people earning enough to build or buy them would dwindle to a trickle. So the policy could very well kill off the one thing that can fix the Auckland housing crisis – the construction of new homes.”
He said the policy would also lead to a dramatic increase in rents over a relatively short space of time as property investors looked for ways to increase income so they could buy more property: “In an environment where every extra dollar enhances borrowing power, landlords will want to maximum rentals and they’ll be able to do it because the Reserve Bank policy will exacerbate the current housing shortage.”
Mr Church said a debt:income policy could also:
- create a further barrier to young people looking to buy their first home, “a prospect already made almost impossible by the Reserve Bank clampdown on loan:value lending”, and
- restrict or eliminate the ability of small business owners to use the equity in their home as security for cashflow, potentially putting thousands of small businesses at risk.
Mr Church said recent house price inflation in Auckland was the result of strong demand and a severe lack of supply, and that the Reserve Bank’s efforts to artificially slow down demand had made the situation much worse.
Reserve Bank says loan:value restrictions have worked
The Reserve Bank introduced loan:value ratio restrictions in 2013 to mitigate the risks to financial system stability posed by a growing proportion of residential mortgage loans with high loan:value ratio (ie, low deposit or low equity loans).
The bank said in its summary of the new paper: “This increase in borrower leverage had gone hand in hand with significant increases in house prices, particularly in Auckland. The Reserve Bank’s concern was the possibility of a sharp fall in house prices, in adverse economic circumstances where some borrowers had trouble servicing loans. Such an event had the potential to undermine bank asset quality given the limited equity held by some borrowers.”
The bank said it believed loan:value ratio restrictions had been effective in reducing the risk to financial system stability.
The bank has produced evidence in its paper that a debt:income limit “would reduce credit growth during the upswing and reduce the risk of a significant rise in mortgage defaults during a subsequent severe economic downturn.
“A debt:income limit could also reduce the severity of the decline in house prices & economic growth in that severe downturn (since fewer households would be forced to sharply constrain their consumption or sell their house, even if they avoided actual default). The strongest evidence that these channels could materially worsen an economic downturn tends to come from countries that have experienced a housing crisis in recent history, (including the UK & Ireland.”
Link: Consultation document: Serviceability restrictions as a potential macroprudential tool in NZ
Attribution: Bank & Property Institute releases, bank paper.