Westpac economists believe RBNZ might use macro-prudential tools within a year to cool the housing market; LVRs won't be the weapon of choice though

The Reserve Bank  might use its new "macro-prudential tools" within a year in an attempt to cool the housing market, Westpac economists say.

However, they don't believe the RBNZ will resort to the much-talked-about potential limits on loan-to-valuation ratios (LVRs).

The RBNZ has been looking at a range of options aimed at addressing the build-up of system-wide risks in the financial sector. Last week, Finance Minister Bill English said that a memorandum of understanding between the RBNZ and Treasury as to how these tools will be used could be signed off by mid-year

The Westpac economists said that despite the seeming urgency around getting these macro-prudential tools in place, they believed that borrowing would need to be growing faster than it is today before these tools were activated.

"The latest credit data for January showed that housing lending has been growing at an annualised pace of around 5% for the last few months.

"That said, if our forecast of a 9% rise in house prices this year pans out, we could still see these tools triggered within a year," they said.

However, while there has been much public discussion around the potential for limits to be placed on how much banks can lend on houses relative to the valuation of the houses, Westpac reckons the so-called LVRs limit is actually the least likely of the four options to be used.

Prime Minister John Key is known to be opposed to it.

The Westpac economists say that in practice such a rule would be difficult to police and they note that this is the only one of the proposed tools that doesn’t form part of the current fabric of banking regulation.

"They [the LVR rules] run the risk of becoming politicised, and they can even be counter-productive by masking the true degree of risk in the financial system. The more likely option is increased bank capital requirements, which is the approach that other developed countries have taken in recent times."

As discussed previously by the RBNZ increased capital requirements could be done a 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 has said 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.