PwC paper commissioned by NZ Bankers' Association says RBNZ's use of macro-prudential tools would result in borrowers paying banks higher interest rates

PwC paper commissioned by NZ Bankers' Association says RBNZ's use of macro-prudential tools would result in borrowers paying banks higher interest rates

By Gareth Vaughan

The Reserve Bank's use of so-called macro-prudential tools to dampen a credit boom or bubble would ultimately see borrowers paying their banks higher loan rates, analysis commissioned by the New Zealand Bankers' Association (NZBA) says.

The analysis, by auditing and financial advisory firm PwC, is included in the bank lobby group's submission on the Reserve Bank's consultation paper on macro-prudential policy instruments and a framework for New Zealand.

The NZBA says it would've liked to see analysis from the Reserve Bank on the costs and benefits of a range of scenarios where macro-prudential tools might be used. But in the absence of this the NZBA says it decided to hire PwC to take a look.

PwC says although macro-prudential tools might be effective at improving financial system stability in a time of solely bank related stress, they don't appear effective in removing wider economic factors that may cause financial system stress, which is a critical reason the Reserve Bank is investigating the possible use of the tools. Furthermore, the use of macro-prudential tools could result in higher mortgage rates, PwC says.

"Our primary assumption is that the deployment of macro-prudential tools is aimed at restricting the supply of funds available to the mortgage market, with a particular focus on mortgages with a high loan-to-value ratio (LVR)," says PwC. "Restricting the quantity of funds available for mortgage lending results in higher borrowing rates for loans."

The four macro-prudential tools the Reserve Bank is considering, 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 LVR residential mortgage lending, which, for example, could mean borrowers having to have at least 15% or 20% equity.

Finance Minister Bill English said in February he expected to sign a deal with Reserve Bank Governor Graeme Wheeler by the middle of the year on the macro-prudential tools, but said they wouldn't be a silver bullet to cool a hot housing market.

NZBA doesn't like LVR caps

The NZBA says use of the tools would come at a cost to the economy and any decision to implement one or more of them must therefore be made carefully. Of the four tools under consideration by the Reserve Bank the NZBA says caps on high LVR residential mortgage lending is its least favoured option, something the Reserve Bank itself appeared to agree with in its consultation material.

The NZBA says there are three "significant problems" for the Reserve Bank in deciding to use macro-prudential tools. The first is identifying that there's an asset price bubble developing, the second is identifying whether it's a credit driven bubble or irrational exuberance, and thirdly what the appropriate policy response is, - whether it be monetary policy or a mix of macro-prudential tools.

Furthermore the NZBA says the use of macro-prudential tools comes down to a judgement about developing circumstances and a decision about the appropriate response.

"The consultation document does not discuss this issue," The NZBA says. "Instead there is an assumption that the boundaries and roles for each of monetary policy and macro-prudential tools are clear when this may not be the case."

"Decisions to implement macro-prudential tools will not be costless to the economy and must be taken with due caution."

The NZBA describes LVR caps as being a "weak tool with low welfare gains from a policy perspective," and being difficult and costly to implement for the banks. And it says the two week timeframe suggested by the Reserve Bank for the implementation of LVR caps by banks is way too short, with three to six months actually required. The NZBA cites the use of LVR caps in Canada, Hong Kong and Sweden, and suggests not all LVR caps are created equally and they are heavily reliant on the specific institutional arrangements that underpin them.

The NZBA goes on to say that if economic policy settings are right, the circumstances in which macro-prudential tools might be used would be rare.

"We would therefore like to see the Reserve Bank play a more visibly public role in the discourse on economic policy settlings."

'Macro-prudential tools could reduce housing supply'

PwC says there are other potential impacts stemming from the introduction of macro-prudential tools that could do with further analysis. These include adverse impacts on residential building, which could hurt the supply side of the housing market. Secondly competition effects within the housing market, with macro-prudential tools having the potential to change the competitive nature of the banking sector, given the potential to provide a short-term competitive advantage to banks with better access to capital and lower cost of capital structures. PwC argues this would give increased market dominance to some banks.

And thirdly, PwC sees potential for "disaggregated effects" such as the reliance of small and medium sized enterprises (SMEs) on the home equity of owner-managers to fund their businesses. It says there's potential for the restriction of capital, and at increased cost, to impose operating and growth restrictions on SMEs.

Furthermore PwC says if the use of macro-prudential tools leads to a contraction in the supply of funds available to the loan market, this is equivalent to a decrease in the demand for funds due to an increase in the effective mortgage rate (EMR). Ultimately the firm says this could impact Gross Domestic Product and employment, which it demonstrates in the chart below using Treasury's long-term fiscal model (LTFM).

The Reserve Bank says the macro-prudential tools wouldn't replace the existing prudential regulation of banks, but would be supplementary tools, used from time to time to help manage risks arising from the credit cycle. The four tools are the ones identified by the Reserve Bank that it says "may" have a role in promoting financial system stability.

The central bank's consultation document runs through four steps the Reserve Bank would take in deciding to apply one or more of the tools, starting with a systemic risk assessment and focus on whether debt levels and asset price imbalances are, or are likely to become, excessive and whether lending standards may be too loose. This will be followed by mulling whether macro-prudential intervention is warranted, selecting the appropriate instrument(s), and determining how the individual tool(s) should be applied.

"In some cases, the optimum response might involve using more than one instrument," the Reserve Bank says. "For example, during a credit boom it might be appropriate to not only constrain the build-up of leverage in the banking system with the countercyclical capital buffer but also to target high risk borrowing more directly (eg through the use of LVR restrictions)."

See all our stories on macro-prudential tools here.

This article was first published in our email for paid subscribers. See here for more details and to subscribe.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


As if the reserve bank has the kahonies to make changes. Ohhh changes, lets talk about them for months or years, get everyones opinion (including those who we will have to bail out) and then decide doing nothing is the best choice.
NZ needs to be more like Singapore in it's decision making.  Yes, not really a democracy, but it damn well gets the job done.

A case of the Lunatics Running The Asylum, no.
is it like the GFC never happened?
As we saw yesterday it seems the banks (OZ) have many abilities not to reduce interest rate costs/interest rate margins to borrowers.
and for high LVR the cost has already gone up.

who is running the show?
The NZBA is a lobbyist .. the New Zealand sub-branch of the ABA

I linked the following article here 3 or 4 weeks ago
Note the critique
Have a close read Gareth

To paraphrase the immortal words of Mandy Rice-Davies "They would say that, wouldn't they"

Laughable, a PR piece from an over-priced dodgy accounting firm commissioned by a vested interest.
So supply and demand, if the costs of borrowing rise, and given its supposed to be a competitive market I wonder, then making it more expensive to buy a house seems a targetted response, which we want. I think the data/experience from OZ on the first time buyers grant shows making it easier to buy pushes up prices, therefore the reverse should hold true and the 80% LVR of texas seems to show this as well.
There your go a counter argument, and I dont charge like a wounded bull either.

Been trying to tell ya all the real score...this lobby group BS is fodder for the silly media and dozy public...Wheeler is jerked every which way by the big bank bosses...and so are English and Key...the banks call the tunes and the rest do the dance.

This reminds me of The Inside Job
I find the lack of integrity by our RBNZ in allowing the OZ banks to dictate how our economy should be run concerning to say the least.
Financial Lobby groups are dangerous for our future as consumers....

For some reason the report didn't list the most obvious reason. If the NZ Bankers' Association want their banks to continue increasing even more record profit and macro-prudential tools restrict the number of people taking loans or the amount they loan, then the remainder are going to have to pay more to increase profits.

Mortgage rates going up is the whole point!
One of the goals was to find a way of increasing borrowing costs for an overheating housing market without increasing rates everywhere else in the economy and without pushing up the kiwi dollar. It's a positive not a negative!

If there is a real concern it could reduce housing supply just make mortgages for new builds exempt.

That may be true but it's still far better to target residential borrowers to control excessive personal debt and an overheated housing market than to hike the OCR and slam everyone.

At least this way our agricultural sector (the engine of our economy) is not hit with higher interest rates and an even higher kiwi dollar.

Folks (Julz excluded), can I request we focus on playing the ball not the man/woman? No one's asking you to agree with the NZBA/PwC views. But rather than just posting drive by style smear comments, why not set out why you think their views are wrong?
Yep, the NZBA lobbies on behalf of its members, that's set out clearly in the story and no one's denying it. But, like you, they're entitled to their view. If you don't agree tell us why it's wrong rather than just dismissing it because of who it's from.
For the record, I've previously set out my own views on the macro-prudential tools here -

The NZBA is preying on highly leveraged homeowners, which apparently is the economy, by publishing a begging piece that should have been sent privately to the RBNZ.
Ad hominem attacks directed at the perpetrators of this nonsense are more than justified.

Stephen, this seems a little inconsistent with your comment regarding Hanover yesterday. There you agreed with Mark Hubbard who didn't want his tax dollars used on a civil case against those behind Hanover because the dispute was between Hanover and its investors.
The argument there seemed to be that Hanover investors had made their own decisions to invest in the company, so caveat emptor.
Aren't they the same type of people making similarly important decisions about taking out loans with banks?
And isn't it good for those highly leveraged homeowners to see what those running their banks are thinking/arguing?

I see no connection - government bodies should not spend taxpayers money in pursuit of civil actions on behalf of private investors - where is the evidence this is happening here?

My question was merely that if one group - Hanover investors - are perceived as being capable of making and living with their own decisions, then shouldn't those who borrow from banks also be regarded as such?
Personally, I'm happy to see the FMA take the civil case and await the outcome with interest.

Personally, I'm happy to see the FMA take the civil case and await the outcome with interest.
You are certainly entitled to your views in this matter - but please never confuse yours with mine.

Gareth, could you provide a direct link to the PwC report so we get access to the ball and can play it?
From the article my impression is that most of the country (and most international ratings agencies and monetary instiutions) considers the housing market a) overheated, and b) a problem. Now dealing with the problem is going to have costs, but are those costs less than the problem. So does the report even recognise there is a problem (because if it doesn't then there is no basis for discussion) and propose alternaitve lower cost solutions to the problem?
To use a possibly unkind metaphor, if everyone in the world is saying there is a drug problem and proposing solutions, if the drug supplier is saying the solutions are bad without prosposing alternative ones or acknowledging the problem, then their unhelpfulness to finding a solution is going to be questioned.

Thank you for the link.
Reading through my first point of comment is that on page 3 they are citing the Price Waterhouse report that macroprudential tools "do not appear to appear to be effective in removing wider economic factors that may cause stress to the financial system", and in several other places as well they are discussing macroprudential at what I would describe as an overly broad level. In fact, in reading the original paper that the extended quote from page 4 is on( There was some sentances from a paragraph that they only quoted part of (p10 of the pdf) where the second quoted paragraph should extend on "Macroprudential policy takes risk factors into account that extend further than the circumstances of individual firms. These include shock correlations and the interactions that arise when individual firms respond to shocks." and a little before the quote was "In general, macroprudential instruments can be defined as primarily prudential tools that are calibrated and explicitly assigned to target one or more sources of systemic risk"
IT feels to me that the document is working towards a slightly straw-man argument that macro-prudential tools when applied broadly to the economy are bad and ineffective, and that this does not address the calibrated and explicitly assigned nature of such tools.
Page 4-7 section i is the NZBA's broad objection to macro tools (section ii is their special objection to LVR) and largely draws on a PWC report. The PWC report (appendix of document) it is based on is explicitly treating the Macro tools as a reduction in the supply of mortgages leading to increase raising the price of borrowing (p4 by the appendix contents). This assumption that underlies the analysis is a highly arguable one. If the macro tools lead to a reduction in the number of people borrowing or a reduction in the amount being borrowed, then in either case there is reduction in the demand for credit. By the same logic that PWC asserted a reduction in credit availability would cause the price of borrowing to rise, any reduction in credit demand should cause the price of borrowing to fall. Particularly if the world is flooded with cheap money looking for a home.
I haven't actually gotten beyond section i yet, and need to go earn some actual money, so more some other time.

This is an interesting use of references in the NZBA submission.
NZBA paper section ii (p7). This is their specific objections to LVR (which largely that in different countries the effectiveness of it depends on how it is implemented). The paper they cite in this section of the document is Suh 2012
I'll say at the outset that I'm not fond of papers based on modelling, preferring ones that draw on historical data. However, I think it important to not that this paper is very positive about Macro tools, and the risk the NZBA submission draws from it for LVR 
"LVR regulation, a household credit market specific instrument, increases the volatility of the business sector by generating regulatory arbitrage" (NZBA submission p7)
Reading Suh to see the details, what that is talking about is that LVR in the household sector increases investment in the business sector, and the NZBA submission is describing this as a risk (because there is more money the sector is more active and volatile). I do not see moving investment from the non-productive household sector to the business sector as a risk, I see it as a benefit.

Crikey..David Chaston, I've just accidentally called Hotchkin and Watson a pair of Cheeky bastards over on another thread...I did qualify it to be "my opinion" and had not thought to seek a collective opinion from former investors with Hanover who may be less tactful than myself.
 And so while this part of the comment offered little to the debate, I  did include clarification of the SFO's position in regard to not being able to opposed to wrongdoing.
 In conclusion my argument to support  the inclusion of "cheeky  bastards" in my comment, was based on the mention of one or both seeking damages to their good name.
Good that's where it gets tricky, because you would be hard pressed to find the wider public having felt any damage had been done to their...good name....

The "mission statement" of is "helping you make financial decisions"
The subtext of this article by the NZBA is
The use of macro-prudential tools will (without question) increase interest rates (read mortgage rates), therefore, if you are contemplating buying a "home" then get in now while the getting is good before rates rise.
 In my opinion, if LVR's were tightened the demand for loans would decrease and banks would have to compete harder for those reduced loans with the excess wholesale funds sitting in their vaults. They would inevitably pay back some of the high cost wholesale funding and the bank's costs would decrease. I think retail rates would come down, not go up.

Iconoclast, would you apply LVR caps to first home buyers? And what would you set the deposit/equity threshold at?

I would like to see some consideration given to applying these tools geographically. If the RBNZ think Auckland and Christchurch prices have overheated because of demand pressure  and that this has risks for banks and for the system they should be able to apply their box of tricks to specific post codes.
The Mortgage Insurers used to do this in a way by having different rules for different locations and by limiting the concentration of loans they would insure in different locations.
It would be one way of controlling the growth of Auckland which is causing all sorts of demands for Government spending to create infrastructure which already exists and is underutilised around the rest of the country.

Australia may cut interest rates next week