By Gareth Vaughan
Is there a need for the Reserve Bank to even have the so-called macro-prudential tools it's now publicly consulting on?
This, says Kirk Hope, CEO of bank lobby group the New Zealand Bankers' Association, is a good question.
"There don't need to be risks (to financial stability within the banking system) for you to develop tools because risks may develop over time," said Hope. "Do I think the Reserve Bank are doing the right thing by thinking about these things? Yeah, they probably are."
"Do I think it will be necessary to implement them? No I don't think there is that sort of risk at the moment, (and) they've sort of signalled that themselves."
"There's obviously certain levels of pressure coming from elsewhere. Again that's something they have to manage in this process I guess," Hope added.
Asked whether this pressure from elsewhere he referred to was coming from politicians, Hope said: "In general political expectations around what can and can't be done in relation to dealing with any kind of asset bubble or change in the credit environment."
"The key thing with the use (of macro-prudential tools) is it's not a mathematical equation about when you would use it. It's a judgement call by a regulator and I think they (the Reserve Bank) have done a fairly good job of outlining what those risks are if they got it wrong, which is quite useful."
The Reserve Bank on Monday issued a consultation paper on the four tools it's considering. Macro-prudential tools are still in their infancy internationally, having swung into regulators' focus as they search for answers to why they couldn't prevent the global financial crisis, or perhaps why they didn't even see it coming.
The four macro-prudential tools, which would only apply to registered banks 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 loan-to-value ratio (LVR) residential mortgage lending.
Submissions close in five and half weeks time on April 10. See our full, detailed story on the consultation paper here.
LVR restrictions on home loans the biggest concern for bankers
From the perspective of the banks, Hope said more detail about the Reserve Bank's propositions was required. Of the four tools under consideration, LVR restrictions on home loans appears to be the one raising the most concerns within the banking industry, even though the Reserve Bank has catalogued a long list of concerns about using them.
Among the country's big five banks, home loans with LVRs above 80% are now up NZ$4 billion, or 12.5%, to NZ$36 billion since the Reserve Bank first mandated the banks break down their home loan books by LVRs in 2008.
On LVR restrictions Hope says: "We'd probably (like to) have the opportunity to engage quite fully on the development of the tool."
In a move that got the attention both of New Zealand economists and politicians, Canada last year took steps to cool its housing market, something many people in New Zealand want our Reserve Bank to do too.
Here in New Zealand, the national median house price was down 4.9% in January, after 2012 ended with a record high national median price. And as of January Auckland prices were still 8.1% higher year-on-year, and the Salvation Army said Housing New Zealand was referring struggling clients to it.
Hope argues Canada's not the best example for New Zealand to follow because things work quite differently there, with the government the major lenders mortgage insurance (LMI) provider.
"LVR comes down to the relationship between restrictions and what is underlying that by way of an insurance market," says Hope. "That's one of the key relationships and that's quite obvious in Canada and Hong Kong (which also has LVR restrictions) with LMI markets with government playing quite a substantial role."
"In Canada, for example, the government play a massive role in loan insurance (through Canada Mortgage and Housing Corporation). Banks are given capital relief because the government guarantees the payment of their insurance in the event that something happens. The market works quite differently here."
Major LMI providers in this part of the world include Genworth Financial and QBE.
The Canadian moves
Last July Canada announced four measures for new government-backed insured mortgages with LVRs of more than 80%. These were:
1) Reduce the maximum amortisation period to 25 years from 30 years. The Canadian government said this would reduce the total interest payments Canadians make on their mortgages, helping them build up equity in their homes more quickly and pay off their mortgages sooner.
2) Lower the maximum amount Canadians can borrow when refinancing to 80% from 85% of the value of their homes. The government said this would promote saving through home ownership and encourage homeowners to prudently manage borrowings against their homes.
3) Fix the maximum gross debt service ratio at 39% and the maximum total debt service ratio at 44%. The government said this would better protect Canadian households that may be vulnerable to economic shocks or an increase in interest rates.
4) Limit the availability of government-backed insured mortgages to homes with a purchase price of less than C$1 million.
Wheeler points to LVR success
In its consultation documents, the Reserve Bank said that whilst the evidence is generally supportive of the effectiveness of LVR restrictions, they've often been deployed in countries with fixed exchange rate regimes, such as Hong Kong, which has its currency pegged to the greenback, and as part of a "micro-prudential framework" rather than as macro-prudential interventions.
That's despite Reserve Bank Governor Graeme Wheeler saying at a press conference last November there had been some success overseas where LVR limits have been introduced with first home buyer exemptions.
"When those measures have been applied they've tended to supply some degree of relief for first home owners. They (LVR restrictions) tend to look more at people who are trading up or people who own second or third homes," Wheeler said.
However, he added that even if such a tool was available, it wasn't something the Reserve Bank believed the current state of the housing market (as of November) justified using. And the Reserve Bank's consultation document doesn't mention the potential for an exemption to LVR restrictions for first home buyers.
Hong Kong research shows LVR restrictions effective at reducing risks from property booms and busts
Meanwhile, a working paper from the Hong Kong Monetary Authority entitled Loan-to-value ratio as a macro-prudential tool - Hong Kong's experience and cross-country evidence, concludes the tool is effective in reducing systemic risk stemming from the boom and bust cycle of property markets. Aside from Hong Kong, the paper looks at 12 other countries, including Australia, Canada, Britain and the USA.
"Although the tool could impose higher liquidity constraints on home buyers, empirical evidence shows that mortgage insurance programmes that protect lenders from credit losses on the portion of loans over maximum LVR thresholds can mitigate this drawback without undermining the effectiveness of the tool," the paper says.
"Our estimates also show that the dampening effect from LVR policy on household leverage is more apparent than its effect on property market activities, suggesting that the policy effect may mainly manifest itself in impacts on household sector leverage."
LVR restrictions have been in force in Hong Kong since 1991 seeing several changes over the years. After the Asian financial crisis, Hong Kong's property prices fell by more than 40% in the year from September 1997 to September 1998. However, the mortgage delinquency ratio never topped 1.43%, relatively low by international standards.
Lenders in Hong Kong have a 70% LVR restriction on residential properties with a value below HK$8 million, 60% LVR restriction on residential properties with a value between HK$8 million and HK$12 million, and 50% on properties with a value at HK$12 million or higher. All non-owner-occupied residential properties, properties held by a company and industrial and commercial properties, have a 50% limit, regardless of property values.
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