The Reserve Bank (RBNZ) says it's prepared to tighten mortgage lending restrictions if it needs to.
It made the comment in its biannual Financial Stability Report released on Wednesday.
It said the "most straightforward" way of doing so would be to tighten loan-to-value ratio (LVR) restrictions further.
"However, the marginal benefits (with respect to financial stability and house price sustainability) are likely to decline as LVR restrictions tighten further while efficiency costs would rise," the RBNZ said.
If the RBNZ was to use a new tool, it said debt-to-income ratio restrictions "would be the best option for supporting financial stability and sustainable house prices over the medium term".
Finance Minister Grant Robertson has said he'd only want such restrictions imposed on investors.
The RBNZ isn't too keen on restricting interest-only lending, as this would "likely have less impact on overall lending conditions than alternatives, while being challenging to implement and enforce".
The RBNZ is expected to report back to Robertson late this month on debt-to-income ratio restrictions and restricting interest-only lending.
It said implementing such tools would be "complex" and "take time to work through".
Recent borrowers more vulnerable
RBNZ Deputy Governor Geoff Bascand explained a high proportion of new lending has had high debt-to-income ratios and LVRs.
"This makes recent borrowers more vulnerable to a rise in mortgage rates, and exposes households and the financial system to a decline in house prices,” he said.
"The recent tightening in LVR requirements, particularly for investor lending, will help to mitigate some of these housing risks and support more sustainable house prices.
“We will be watching how market conditions respond to the Government’s recent policy changes."
As of May 1, the RBNZ has required at least 95% of banks' mortgage lending to investors to have deposits of at least 40%. As of March 1, they only needed a 30% deposit.
And as of March 1, at least 80% of mortgage lending to owner-occupiers has required a deposit of at least 20%.
The RBNZ removed LVR restrictions last year due to COVID-19.
It warned in its report the likelihood of a "significant" housing market correction has increased.
It said the future path of mortgage interest rates depends on the evolution of inflationary pressure and adjustments of the monetary policy stance at home and abroad relative to neutral rates, as well as credit risk in the housing market.
"Estimates of trend interest rates are higher than current levels, as shown in the Reserve Bank’s February Monetary Policy Statement," the RBNZ said.
"More recently, the Government’s extension to the bright-line property tax and the phased removal of interest expense deductibility will over time reduce the returns on investment property, particularly at high levels of leverage.
"Taken together, the various downside risks to house prices mean that the likelihood of a significant correction has increased."
Banks' core funding ratio rules to return to normal next year
The RBNZ also said it intends to increase banks' minimum core funding ratios (CFRs) back to where they were pre-COVID-19, as of January 1, 2022.
The change will only be made if there isn't a "significant worsening in economic conditions".
CFRs ensure banks fund a minimum proportion of their lending with stable long-term sources.
The RBNZ lowered banks' CFRs from 75% to 50% in April 2020.
The RBNZ, in its report, also reaffirmed banks will need to start holding more capital from July 1, 2022. COVID-19 has seen the start date of these new rules delayed by two years.
As for insurers, the RBNZ said new capital rules will start being implemented from October 1 this year, with increases in minimum requirements starting in July 2022.
Here is a copy of a press release from the RBNZ:
While New Zealand has so far come through the COVID-19 pandemic better than initially feared, vulnerabilities in the financial system remain, Reserve Bank Governor Adrian Orr says in releasing the May Financial Stability Report.
“Successful public health measures along with substantial monetary and fiscal policy support, helped to prevent many business failures and a larger rise in unemployment. Key New Zealand export prices have also been resilient, with dairy prices at their highest level in several years.
“Yet, despite doing better than feared, border restrictions, supply chain disruptions, and social distancing have reduced activity in affected sectors, and some businesses remain vulnerable.”
We are also seeing the impact of low global interest rates resulting in increased risk taking and higher asset prices. This is an international phenomenon, with the New Zealand impact most visible in higher house prices.
A high proportion of new lending has had high debt-to-income and loan-to-value ratios (LVR). This makes recent borrowers more vulnerable to a rise in mortgage rates, and exposes households and the financial system to a decline in house prices, Deputy Governor Geoff Bascand says. The recent tightening in LVR requirements, particularly for investor lending, will help to mitigate some of these housing risks and support more sustainable house prices.
“We will be watching how market conditions respond to the Government’s recent policy changes. If required, we are prepared to further tighten lending conditions for housing using LVR requirements or additional tools that we are assessing,” Mr Bascand says.
Government support and strong capital and liquidity buffers have meant that the pandemic has had a limited impact on financial system soundness, but further resilience is needed.
Most insurers have maintained or improved their capital positions over the past year. Solid profitability and dividend restrictions have allowed banks to build their capital levels, providing a buffer to absorb any future losses, and overall banks are in a strong position to keep supporting their customers and the economy. New capital rules will start being implemented from 1 October 2021, with increases in minimum requirements starting in July 2022 to support resilience in the future.