The Reserve Bank says the potential benefits of DTI restrictions would significantly outweigh banks' costs

The Reserve Bank (RBNZ) has released details of the framework for its long-proposed debt-to-income (DTI) restrictions for borrowers taking out loans to buy residential property, saying separate DTI limits for owner-occupied and investment property could be possible.

The RBNZ has also included some estimates of the administrative costs to banks of implementing the framework, but says the benefits of DTI's will outweigh these. 

DTI limits are calculated based on a simple ratio of borrower debt divided by borrower income. The RBNZ says it hasn't made a decision to activate DTI restrictions, and nor has it established a particular DTI setting at this stage.

A so-called macro-prudential tool like loan-to-value ratio (LVR) restrictions, the RBNZ has been proposing that if a DTI limit is introduced, it would be just one across both owner-occupiers and investors. But it's now showing more flexibility on this.

"In response to feedback on the DTI framework consultation, we have decided to include the option of separate DTI limits for owner-occupied and investment property within the framework, as currently exist for the LVR restrictions. Although our analysis to date suggests that it may not be necessary to have differentiated limits, given that the impacts of a uniform DTI restriction are likely to bind predominantly on investors and higher-income borrowers, incorporating the option of differentiated limits into the DTI framework design will enable us to adjust the relative impacts in the future if required," the RBNZ says. 

"Another point to consider in this context is the interaction between DTI and LVR restrictions... it is possible we could loosen LVR settings if and when DTI restrictions are in place, while still maintaining our financial stability objectives. This would benefit first-home buyers, since saving for a deposit on a first home can be challenging particularly for those on lower incomes."

Long running process

The RBNZ has wanted to have a DTI tool in its macro-prudential toolkit since at least 2016 but struggled to secure government support from firstly the National-led government and then the current Labour government due to concerns about the potential impact on first home buyers. It finally gained support from Finance Minister Grant Robertson in June 2021 as the housing market ran rampant.

The RBNZ has made no commitment to enforce DTI restrictions. Rather it has previously indicated it could have a DTI limiting tool for lenders to use on borrowers taking out home loans ready to go in March 2024. It's still going by this timeline, with the banks therefore getting 12 months to get their systems ready, should they be required. The RBNZ says given the housing market is currently in a downturn, there's no immediate need to implement DTI restrictions.

In the Regulatory Impact Assessment released by the RBNZ on Monday the central bank says the costs of DTI restrictions include administrative costs for banks and "allocative efficiency costs" from reducing credit availability to some otherwise credit-worthy borrowers.

"Our analysis indicates that the potential benefits of DTI restrictions would significantly outweigh their costs," the RBNZ says.

"The DTI framework incorporates design elements that will mitigate efficiency costs – in particular, the use of exemptions for certain types of borrowers, and ‘speed limits’ which allow banks to continue extending some loans to borrowers above the DTI threshold. In addition, introducing DTI restrictions may enable us to loosen LVR restrictions on residential mortgage lending while maintaining our financial stability objectives. This would have an offsetting benefit for allocative efficiency."

The RBNZ highlighted some of what will be involved for the country's banks, who will need to incur administrative costs to prepare for the potential implementation of DTI restrictions.

"These costs include changes to IT systems and training staff on the application of the restrictions," the RBNZ says.

"In our consultation on the DTI framework, we asked lenders if they could provide an estimate of the scale of these implementation costs. Respondents generally indicated that it was challenging to quantify costs at this stage of the process. However, based on the figures we received, we estimate that the system-wide costs of changes to IT systems could be in the range of $1.25 million to $2.5 million.

"We did not receive any quantitative estimates for the costs of staff training or other implementation costs. However, we note that even if these costs were significant – for example, if the total implementation costs were in the range of $10 million – this would be a small figure relative to the potential scale of both the financial stability benefits and allocative efficiency costs of DTI restrictions."

The RBNZ says if the DTI restrictions are actually activated, the costs and benefits of them will depend "to a significant extent" on how they are calibrated.

"We will assess the impacts of different calibrations separately prior to any decision to activate DTI restrictions. As part of this assessment we will also consider the interaction between DTI and LVR restrictions."

No immediate need

The RBNZ acknowledge that the housing market is currently in a downturn "and we do not see an immediate need to implement DTI restrictions".

An alternative therefore would have been to not put in place the DTI framework now, "but instead to wait and assess whether DTI restrictions are needed at a future stage of the housing cycle".

"While this would avoid administrative costs to banks in the short term, there is a significant chance that if the housing cycle turns and financial stability risks begin to rise, there would be insufficient time to put the framework in place to address these risks. This is because banks have requested a lead time of 12 months to prepare their systems for the potential implementation of DTI restrictions."

Much has been said in the past about the potential impact of DTI restrictions on first home buyers. The RBNZ says the impacts of DTI restrictions on first-home buyers will depend on how they are calibrated.

"However, our analysis indicates that DTI restrictions will generally impact more heavily on investors and higher-income home buyers, who borrow at higher DTI ratios on average.

"Our Memorandum of Understanding with the Minister of Finance on macroprudential policy requires us have regard to avoiding negative impacts, as much as possible, on first-home buyers, to the extent consistent with our financial stability objectives. We are also required to have regard to financial inclusion more generally under our Financial Policy Remit. It should be noted that lending to first-home buyers, like other borrowers, is subject to bank tests of debt servicing affordability independent of whether DTI restrictions are in place."

RBNZ Director of Prudential Policy Kate Le Quesne says publication of the framework now does not immediately activate DTI restrictions or set a calibration, or level, for them.

"Instead, it provides banks with clarity in terms of the definitions of debt and income and future data reporting requirements, and it provides them with a timeframe for making any changes to their internal systems and processes to be able to comply with a possible DTI restriction in future," she says.

"DTI restrictions on residential mortgage lending, when implemented, set limits on the amount of debt borrowers can take on relative to their income. This supports financial stability by limiting higher-risk mortgage lending, thus reducing the likelihood of a future housing-related financial crisis.

"This in turn helps us to meet our statutory objective of ‘promoting the maintenance of a sound and efficient financial system.

"By linking credit availability to income growth, DTI restrictions complement other tools we use to support financial stability, including LVR restrictions on residential mortgage lending."

The RBNZ announced its decision to add DTIs to the central bank's 'macroprudential policy toolkit' in April 2022 and a public consultation on the exposure draft of the DTI framework was held in November 2022.

"Stakeholders were generally supportive of the proposed design of the DTI framework and agreed with our overall approach to keep the framework simple and clear," Le Quesne says.

More of the documentation released by the RBNZ is available here.

*Additional reporting Gareth Vaughan.