Opinion: What are the 4 macro-prudential tools the RBNZ is looking at and will any of them actually be used to cool an over heating housing market?

What's inside and does it have any clout? Image sourced from Shutterstock.com

By Gareth Vaughan

Will the development of the Reserve Bank's so-called macro-prudential tools give it any silver bullets to fire at an over heating housing market?

Based on the statement accompanying the Reserve Bank's latest Official Cash Rate review the boffins there are getting worried. Their concern appears to be over the return of double digit annual house price growth, New Zealanders leveraging against the rising value of their homes to splurge on cars and flat screen TVs, and the potential for a major house price correction at some point.

As politicians at both a local and national level bicker and promise, demand outstripping supply has seen Auckland and Christchurch lead the national median house price up 10% over the past year with housing affordability, alongside unemployment, this year's big political issue. Now focus is going on the Reserve Bank and its toolbox.

So could any of the macro-prudential tools the central bank boffins, their Treasury counterparts and Finance Minister Bill English are looking into, work as a hand brake to slow down an overheating housing market? Or could they go even further and encourage banks to lend more money to productive, job creating businesses and rein in residential mortgage lending?

A consultation paper on the tools is due out sometime in March.

So let's take a look at exactly what the four macro-prudential tools under consideration are, what impact they might have, and what the Reserve Bank has already had to say about them.

One: The counter cyclical capital buffer - ambulance at bottom of cliff

Firstly there's what's known as a counter cyclical capital buffer.  The Reserve Bank has given itself the discretion to utilise this tool from 2014. It would be a buffer of common equity added to banks' regulatory capital requirements during periods of "excessive" credit growth. The aim would be to help protect the financial system during a subsequent downturn. The Reserve Bank says it could vary from 0 to 2.5% of risk-weighted assets, but it's possible no formal maximum size will be set, meaning the scale could be set according to circumstances.

It would come on top of existing capital adequacy requirements including a new 2.5% conservation buffer being brought in from 2014. The conservation buffer's designed to ensure banks maintain breathing space above the minimum capital ratio requirements to be used to absorb losses in times of financial and economic stress. Banks' minimum tier one capital ratio, representing shareholders' funds in the bank, is now 6% of risk weighted exposures. Banks' minimum total capital ratio is 8%.

The Reserve Bank has said banks will get up to 12 months notice before the implementation of a counter cyclical credit buffer.

Two: The core funding ratio - banks in clover

Secondly is the core funding ratio.

Introduced in April 2010 as a move designed to reduce New Zealand banks' reliance on short-term overseas borrowing, the core funding ratio initially set out banks had to secure at least 65% of their funding from either retail deposits, or wholesale sources such as bonds with maturities of at least a year.

Lifted to 70% in 2011 and then 75% from January 1, the latest Reserve Bank data shows banks' had a combined ratio of 85.2% at the end of November, or NZ$236.5 billion worth of core funding.. So they're not exactly struggling with it.

Even if it's lifted higher still covered bonds, which carve off residential mortgages written by the banks as security and for which there's a strong appetite especially in Europe, and vanilla bonds issued cheaply to yield deprived overseas investors like the Swiss, both qualify. We're also in an environment where the banks have taken in NZ$29 billion more in deposits than they've lent out over the last three years.

Lending growth is showing signs of a resurgence however. December home loan growth rose 3.7% year-on-year, its fastest rate since January 2009. Agriculture debt was up 5.1%.

Three: Increasing the risk weight on mortgage lending - hasn't slowed rural credit growth

Thirdly is adjustments to risk weights on sectoral lending. Basically this means changing the amount of regulatory capital banks must hold against loans in case they go pear shaped.

Gareth Morgan, for one, is excited at the prospect of this. But Reserve Bank Deputy Governor Grant Spencer recently wrote a widely published article seemingly trying to hose down expectations that changing risk weights on residential mortgages, about 56% of bank lending books, would lead to significant change in lending behaviour.

Regulatory capital minimums on residential mortgages are lower than those on other lending such as business and farm loans, personal loans and credit cards. For example, ANZ's most recent disclosure statement shows a 26% risk weight on retail mortgages, a 59% one on corporate (business and farm) loans, and 73% on other retail including personal loans and credit cards.

It's also worth noting the rules differ among the banks. The big four banks - ANZ, ASB, BNZ and Westpac - use what's known as the internal ratings-based approach. This means they build their own models to calculate their regulatory capital requirements and must then get them approved by the Reserve Bank. All other banks run what's known as the standardised approach where the Reserve Bank prescribes their risk weights.

For the big four, capital requirements are determined by multiplying risk-weighted assets by 8%. (See table below).

By increasing the risk weight on an asset class, such as home loans, banks' incentive to lend to that sector could be reduced because it should cost them more to do so. And if banks' pass their increased costs on to customers, the latter will pay higher interest on their loans. However, the Reserve Bank argues banks' own funding costs, their assessment of the riskiness of a loan or sector, and their competitive positioning are, and always will be, the most important factors setting loan pricing.

In terms of credit growth, let's look at what has happened since the Reserve Bank tightened the rules on the big four banks' farm loans in June 2011. It did this in the wake of falling dairy payouts and concern over loose rural lending by the banks. The changes mean the big four banks now have to apply risk weights of up to 90% of a farm loan instead of 50%. All other banks already had to apply risk weights of 100% to all farm loans.

Note the Reserve Bank did initially delay the increases to farm loan risk weights after banks said the move would see farmers paying between 30 and 50 basis points more to borrow.

And what has happened to rural lending growth since June 2011? It's up NZ$2.6 billion to a record high of NZ$49.77 billion. The Reserve Bank warned in November's Financial Stability Report the dairy sector appeared more vulnerable to a sharp decline in the payout than at the time of the peak in dairy prices four or five years ago.

Back to risk weights on home loans. I for one won't be holding my breath for major changes to be made given Spencer's article said: "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."

Four: LVR limits - John Key not a fan

And fourth is limits on loan-to-valuation ratios (LVRs). This, for example, could set out a rule whereby borrowers must have a deposit of at least 20% when taking out a residential mortgage. It could also exclude first home buyers.

Worth noting here is the Reserve Bank looked at this option seven years ago and dismissed it. On top of this Prime Minister John Key has publicly expressed scepticism about this concept.

In 2005-06, at the height of the naughties cheap credit bubble, Reserve Bank and Treasury boffins teamed up in what was called a Supplementary Stabilisation Instruments project. This looked into tools, directly affecting the housing market and/or the market for residential mortgage credit, that could supplement the central role of the Official Cash Rate in managing inflation. The tools they looked at included LVR limits.

In a letter to Finance Minister Michael Cullen in March 2006 Reserve Bank Governor Alan Bollard and Secretary to the Treasury John Whitehead concluded: "There are no simple, or readily implemented, options that would provide large payoffs in the near-term."

An LVR limit, on all loans secured on residential property by all lenders would have a direct impact on the most leveraged portion of the housing market, Bollard and Whitehead said.

"However, the rules for such a limit would be difficult to define and difficult to enforce. The pressure for disintermediation would be very great. The report also notes that the segment of the market most affected by this measure contains a high proportion of low income earners and first home buyers."

And the report itself said: "This instrument should not be developed further."

Meanwhile, Key has said: "Any consumer can effectively go around that [LVR controls]. All historical attempts to stop that haven’t been very successful."

“You can certainly protect the banks’ balance sheets from over-exposure to the property market, but the capacity of someone to go to their friend or lawyer or some other institution to get that other piece of equity that they don’t have, is always real," added Key.

Bollard blamed past LVR limits for the growth of finance companies

And in even stronger criticism of the concept than in his 2006 letter to Cullen, Bollard told interest.co.nz last year:"A loan to value ratio might be the least desirable of the ones we might look at."

 

"Those sorts of direct interventions (were used in the 1970s) and they ended up with lots of distortions, and they ended up with people finding other ways to get money, and that's where some of our current crop of finance companies came from, ways to get around bank regulation in the 1970s," Bollard said. "They're distortions."

It's hard to believe the view on LVR limits has changed much at the Reserve Bank since the arrival of new Governor Graeme Wheeler. However, responding to a question at a November press conference he did at least note there had been some success overseas where LVR limits have been introduced with first home buyers exempt.

"When those measures have been applied they've tended to supply some degree of relief for first home owners. They tend to look more at people who are trading up or people who own second or third homes," Wheeler said.

But he then went on to say that even if such a tool was available, it wasn't something the Reserve Bank believed the current state of the housing market justified using.

Epiphany or politicians

And as Spencer pointed out at the same November press conference macro-prudential tools are about countering systemic risks, i.e. protecting banks from themselves, rather than necessarily cooling a housing market with growing affordability problems.

"We would have to consider, in order to use such a tool, that there was really a risk situation that was building in the banking system that needed countering through macro-prudential policy that wasn't being handled sufficiently by the micro-prudential tools that we use as a matter of course," said Spencer.

So unless there's a major epiphany at the Reserve Bank and Treasury within the next few weeks, it looks like any serious steps to cool the housing market are up to the politicians.

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23 Comments

Show me the Macro Prudential Tool that stops overseas domiciled investors with cash from turning Auckland into a city of renters!
Then ask Jonkey and Double Dipton to add their two cents worth.

Gareth Vaughan: says "unless there's a major epiphany at the Reserve Bank and Treasury within the next few weeks, it looks like any serious steps to cool the housing market are up to the politicians"
 
A year ago a "central banker" stated that Monetary Policy and Fiscal Policy should oppose one-another. If government fiscal policy is being profligate or stimulatory then the central bank should pull the monetary policy lever into the up-position. One lever should not be fanning the flames of  the other. Equilibrium should be where the two balance one-another.
 
Here's a couple of questions for you
 
If the problems being experienced are the result of poor "fiscal policy" should it not be the responsibility of the fiscalliers to amend the policy
 
Basel Brush asks a very good question
What Monetary Policy levers do you know of that will inhibit the price setters?
(a) cashed-up financial foreign escapees (refugees) who dont need to borrow
(b) cashed up local cowboys who dont need to borrow
 
Here is an interesting post from raegun (Bay of Plenty) in the NZHerald (12:05 PM Sunday, 3 Feb 2013) in response to Bernards Trainwreck article.
If you introduce an LVR you would have to, at the same time, curb foreigners buying up property. An LVR making it harder for (local) people who have to borrow would only make it easier (cheaper) for those who don't. An LVR on its own will only exacerbate the problem.
 
Further measures would be to "seed" provinces to encourage people back to them, and break down centralization. Start with scrapping the "no go" areas for WINZ, Oamaru is apparently one, there is not enough work to go round, and even getting some bendficiaries with limited spending power back in the provinces would help, and the housing top up bill would go down. Give tax breaks to businesses setting up in the provinces.
 
CGT - this is not so much a revenue gathering exercise but a deterrent
And the state, for now, will have to get back in the business of providing housing for some.

 
Pick which of those measures the RBNZ has the power to implement. Government (fiscal) policy of no-go zones is simply creating a never-ending supply of renters for the rentiers.
 

If an LVR restriction is too unpalatable for the politicians, how about making all new mortgages non-recourse like in the USA? That would force lenders to think twice about how much they lend and on what types of property. LVR levels would quickly readjust without requiring ongoing intervention. It just takes a bit of a re-write of the Property Law Act.
 

There is nothing wrong with overseas investors putting their money into NZ.
For every dollar invested by foreigners, somebody here receives it.
It makes no difference as money does not distinguish between owners and bank accounts remain level
with the only difference being the name of the bank holding the funds.
Land can not be taken away and whom owns it is irrelevant.

BD
Buying houses by investors who have little if any interest in our country, is not investment that has any productive gains for the country.
All  it does is allow income to be taken that probably is never seen by our IRD to help provide the services that you expect as of right.
If the investment is put into a productive enterprise that helps the tax base either by paying tax or providing employment that prevents the dole then I can accept your argument. however bland statements like the on you offer above does nothing to make it right with many of us.
There are far too many who give little thought to the whole argument and consequently think the rest of New Zealand owes them the lifestyle they have cut out for themselves by their manipu;lation of system.
 

Yeah. You want an example of DUMB?
I wonder if the captains, or anyone else for that matter, realise that a non-nz-resident who is a resident of either the US or AU, who invests in property in NZ, and makes a capital profit, while not paying CGT in NZ, will pay CGT on that profit in the country where they are a resident for tax-purposes? Their home country. Under cross-border tax-treaties they will receive a full-tax-credit for the amount of tax paid in NZ. ie ZERO.

What's the problem...the economy is being milked by the banks...and the govt is taking some tax cream off the profits...using the cream to buy votes...that's what the 'infrastructure splurge' is all about....it's 'make work'  wrapped up in BS.
So any expectation that Wheeler et al will be allowed to throttle the bank profit and govt tax flow is just a pipe dream.
Wheeler's job is to jawbone and look serious while spouting the usual rot for the benefit of the media.

Fact boy wants a dictatorship to control our lives and fortunes.
Unfortunately for him we have democracy and we have choices.
If he wants draconian regulations he should stand for parliament and when he gets elected he can give it a go.

I suggest you read the Green's housing policy, as a landlord do sit on a toilet when you do, because the odds are thats your future in 2014-5.
regards

I agree Bigdaddy, it really is a no brainer!  We need to eliminate all the current draconian regulations and sell as much of our assets and land to foreign buyers immediately. The longer we hold onto our land and assets the worse off we are! 
 
Just think of the millions of dollars NZ could make if we sold all of all of our land to the Chinese!! They'd probably buy all of it too! What suckers, shame they aren't 'business smart' as us kiwis are eh!

Wouldn't it be easier to assist in the building of new houses , freeing up the land supply , taking GST off materials and labour , cutting compliance costs ....
 
.... increasing the housing stock  .... rather than trying to deter investors....
 
" cooling " mechanisms can only work for so long , the demand  pressure will continue to build up , causing another pop of the cork , at some stage ....
 
Current supply of houses doesn't match demand ... what is so difficult that the pollies ( local & national gumnut ) don't get that ?

GBH - We can't expect them to look for easy options - heck can't have that happening that might mean admitiing that someone in a Poitical or Bureaucratic position created the problem in the first place. Too many......I don't want egg on my face people....wondering around.
 
Contraints creates higher demand. The idiots only have to view other things like 6 O'clock swill if they don't understand. 

Put Steven Joyce in charge. After his committee has spent half a million investigating NOVAPAY then they can spend another half million investigationg this.
When the report is finally released things will haven gotten much worse so another committee will have to be set up........................blah, blah, blah

 
Investment by those overseas is NOT okay when it impoverishes those in NZ, which is what it is doing in Auckland.
Investment in NZ assets is great, as long as those investments benefit NZ or NZ'ers.
Why do you think every other country with its act together, limits overseas investment in residential property?
Is John Key Stupid? Can he not see this glaringly obvious issue?
 

Good morning Mr Wheeler, the mission we have for you is to read this report over your breakfast...
http://abcnews.go.com/International/wireStory/argentina-freezes-prices-break-inflation-spiral-18402124
 We do not expect that Tweak or Fiddle will bother themselves with this warning ...!

Gareth
Really useful piece. Cheers.
I agree. The RBNZ and the government seem genetically reluctant to use these tools, particularly the LVR tool.
Yet they are now being used in Israel, Canada, Singapore and Hong Kong, none of which are known for doing radical, unorthodox or dumb things.
cheers
Bernard

BH - Contraints on anything actually creates more demand.
 
Remove the contraints and the market will level out.
 
Increasing the supply of land, removing the RMA and Council bureaucratic costs involved in housing and the price will level out.
 
Where is the evidence that the macro-prudential tools will lower property prices?
If evidence did exist that these tools could work then it would be able to be proven.
 
There is more evidence to suggest that the LVR tools will not be affective in balancing or lowering prices.
 
 
 
 

Dream on, notaneconomist.

Absolute rubbish, for a "notaneconomist" your sure push austrian economics fanatically.
regards

Absolutely correct , notaneconomist ...... we need to ramp up the supply of houses ...
 
.... we can continue to borrow more to raise the prices of the existing housing stock  , or we can use that munny to construct new houses ...
 
Seems a no-brainer to me .

a few points:
- LVR is not a perfect tool, but can it be any worse than the OCR whose lowering is intended to provide a lifeline to productive business but instead produces speculative bubbles. Everything has unintended consequences, just some worse than others. 
- will it hurt FHBs the most? no, cause prices will drop to reflect the lesser credit supplied demand in the market. If they go looking for finance companies then why cant you follow the money trail and apply the same LVR ratio there? it should apply to ALL lending with residential property as security (I am assuming even finance companies would ask for the ppty as security).
 

Who was around , buying their house with LVRs ?
"Those sorts of direct interventions (were used in the 1970s) and they ended up with lots of distortions, and they ended up with people finding other ways to get money, ...........
Yes, for a few, parents who could afford it could , over time, build up their   childrens home loan/ farm loan, tax free savings account  till they reached a 20% deposit...or the parents died and what was left in the estate added to their savings....For the marjority it was head down A up work and saving....Also not mentioned above, for other high cost items, like cars, expensive furniture also required a 20% deposit/savings
The pollies and RB want more savings, and pull in high risk (no longer called subprime) lending...seems LVR hit both of those.. but not good for the vote count at election time.
"....and that's where some of our current crop of finance companies came from, ways to get around bank regulation in the 1970s,"
Seems everyone takes that statement at face valve...Muldoon, yep that guy who had our fiscal policies so tied up, down to rent and wage freezes, then allowed finance companies rise up to get around his regulations.... YEAH RIGHT.
That statement needs some very close questioning... The whole 'arguement against this tool needs far deeper scritineereing, not accepted at face vaule
Steps.
A good informative articule by GM, lacks a little depth in places thu

A good thread folks, cheers.