The Reserve Bank (RBNZ) has clarified loan-to-value ratio (LVR) restrictions are here to stay, and won’t be completely removed if debt-to-income (DTI) restrictions are introduced.
In other words, the RBNZ won’t ditch the type of restrictions it’s currently using to regulate banks’ mortgage lending if it starts applying new types of restrictions, aimed at strengthening the financial system in a different way.
Sure, the RBNZ might ease LVRs if it introduces DTIs, but it isn’t planning to remove LVRs altogether. In fact, it sees LVRs as a “permanent device to maintain resilience of the financial system”.
The RBNZ also plans to start publishing projections for how it sees itself applying these macroprudential tools.
These were key messages RBNZ Deputy Governor Christian Hawkesby delivered in a speech on Thursday morning.
LVRs and DTIs complimentary
His comments follow the RBNZ on Wednesday announcing plans to work with banks to get ready to start implementing DTIs by mid-2023 “if required”.
With a number of factors seeing the housing market turn, and credit conditions tighten, the RBNZ signalled it would take a cautious approach towards potentially implementing the new type of restriction.
DTIs would limit the amount of mortgage lending banks could provide to borrowers seeking a lot of debt relative to their incomes.
The LVR restrictions currently in place require borrowers to have certain sized deposits relative to the debt they’re seeking.
While some banks argue it would essentially be an overkill for the RBNZ to apply LVRs and DTIs at the same time, Hawkesby said the tools were “complimentary”.
“LVR restrictions help us manage the loss given default in a period of widespread default on mortgage lending,” he said.
“Including a debt-to-income measure in our toolkit would help with reducing the probability of default.
“Therefore, these two policy tools deal with different sources of risk: LVRs with the risk to banks from a fall in house prices, and DTIs with the risk to households from a fall in income.
“We see reducing the probability of default and loss given default as two complementary policies in creating a more resilient financial system.”
Interest rate floors could still be set
The RBNZ on Wednesday also said it wouldn’t follow through with its proposal to set interest rate floors as an interim measure while establishing a DTI regime.
The regulator deemed it unnecessary for it to set a minimum interest rate for banks to test mortgage applicants at, as it noted banks’ test rates have started rising in line with market rates, and the RBNZ expects to see a slowdown in lending to borrowers taking out a lot of debt relative to their incomes.
Nonetheless, Hawkesby in his speech, underlined the benefit of the RBNZ being able to introduce such restrictions if required.
He said the RBNZ believed it was “important to have a fuller suite of macroprudential tools, which help manage both the risks to the financial system from a fall in house prices and the risks to households being unable to service their debt”.
Putting macroprudential policy on an ‘equal analytical footing with monetary policy’
So, as the RBNZ looks to use more tools to ensure the financial system as a whole is stable and efficient, Hawkesby said it has to enhance the way it communicates.
He said public understanding and support of its actions are key to the regulator maintaining its “social licence” to operate.
He said the RBNZ would need to explain whether its macroprudential settings are contractionary or expansionary, and outline “how they combine in total to a neutral long-term setting to support financial stability through the cycle”.
Hawkesby said the RBNZ should also aspire to publish projections of its macroprudential settings, like it publishes projections for where it sees the Official Cash Rate going on the monetary policy side of things.
“All of these considerations are part of the building blocks we need to put macroprudential policy on an equal analytical footing with monetary policy, and to find the rhythm of following a consistent, repeatable process backed by clear and transparent communication,” Hawkesby concluded.
The RBNZ will have more to say on these issues when it releases its Financial Stability Report on May 4.