RBNZ to force banks to hold more capital to back high LVR mortgages from Sept 30; says will result in average increase in capital for housing of 12%

By Bernard Hickey

The Reserve Bank of New Zealand has announced the big four banks will have to hold more capital to back high loan to value ratio (LVR) mortgages - above 80% - from September 30. It expects the changes to start affecting bank behaviour in the mortgage market immediately.

It said it expected the move would force the banks to hold an extra 12% of capital for backing mortgage lending. Later in a news conference, Deputy Governor Grant Spencer said he did not expect the changes would increase interest rates for such high LVR loans by much and he did not expect the banks would have to either retain dividends or raise fresh capital, given they already have significant capital buffers.

The move was signaled in March as part of a review of risk weighted capital requirements for banks after a surge in high loan to value ratio lending over the last year. The bank announced the change in its half yearly Financial Stability Report where it also warned fast-rising house prices were increasing risks to financial stability.

"“Housing pressures are increasing risk in the financial system,” Reserve Bank Governor Graeme Wheeler said.

“House prices relative to disposable incomes are already high by international standards. Further price escalation will worsen the potential damage that could result from a housing downturn following an economic or financial shock," Wheeler said.

The Reserve Bank said the changes to capital rules for high LVR loans would result in an average increase in the capital held for housing of around 12%. Deputy Governor Grant Spencer said the first stage of a review of capital requirements for mortgage lending had been completed. See more on the capital rule review here.

“Looking forward, we want to ensure that bank capital requirements adequately reflect the risks around housing lending and accordingly we are undertaking a housing capital review," Spencer said.

"In the first stage of this review the Bank is increasing the risk weights applying to high LVR housing loans for the four major banks that use their own models as a basis for calculating minimum capital requirements," he said.

“The increase in the risk weights, applying to all current and new high LVR loans for the major banks, will result in an average increase in capital held for housing of around 12 percent and will take effect from 30 September 2013."

Meanwhile, the Reserve Bank said it was close to signing a memorandum of understanding with Finance Minister Bill English for a framework for using macro-prudential tools, which had been foreshadowed for mid-2013.

The bank said it did not envisage major changes to the proposals for the framework it proposed in early March, which included changes to the rules for bank core funding ratios, a counter-cyclical capital buffer, specific capital requirements for lending to certain sectors, and restrictions on high LVR lending.

Spencer said the Reserve Bank would consult further with banks over the next two months to "establish the implementation details of the various instruments so that we are able to use them as necessary."

Full statement below:

RBNZ concerned over growing financial stability risks

While the financial system remains sound, developments in private sector credit and the housing market point to increasing risks to financial stability in New Zealand, Reserve Bank Governor Graeme Wheeler said today, when releasing the Bank’s May 2013 Financial Stability Report.

“Housing pressures are increasing risk in the financial system,” Mr Wheeler said.

“House prices relative to disposable incomes are already high by international standards. Further price escalation will worsen the potential damage that could result from a housing downturn following an economic or financial shock.

“Our concerns are shared by the OECD and by the IMF in its recent review of the New Zealand economy. Housing risks have also been noted recently by all three of the major international credit rating agencies.

“Housing pressures, arising from pent-up demand, limited supply and the lowest interest rates in 50 years are being felt particularly in Auckland and Christchurch, where supply constraints are greatest. Demand is being underpinned by easier credit conditions, both in terms of lower mortgage rates and an increased willingness by banks to lend at high loan-to-value ratios (LVRs).”

Mr Wheeler said a strengthening of global financial market sentiment in recent months is contributing to the easier conditions by reducing bank funding costs and making offshore funding more readily available.

“Global sentiment is also contributing to New Zealand’s overvalued exchange rate, which is continuing to hinder a rebalancing of activity towards the tradables sector that would assist in reducing external vulnerabilities.”

With the credit cycle now turning upwards, there are signs that the post-GFC recovery in household savings may be stalling. Household debt is rising from a level that is already high relative to incomes. Leverage in parts of the agricultural sector also remains high, and borrowing by the sector is increasing at a time when recent drought conditions could expose financial vulnerabilities for some farmers.

“Reflecting our concerns around housing sector developments, the Reserve Bank has been developing a macro-prudential policy framework. We have recently consulted on this framework and will soon be signing a memorandum of understanding with the Minister of Finance to confirm the key elements of the policy, including governance arrangements,” Mr Wheeler said.

Deputy Governor Grant Spencer said that, while housing risks are growing, banks are performing well financially and have strong balance sheets. Their capital levels comfortably meet the new Basel III requirements that took effect in January.

“Looking forward, we want to ensure that bank capital requirements adequately reflect the risks around housing lending and accordingly we are undertaking a housing capital review. In the first stage of this review the Bank is increasing the risk weights applying to high LVR housing loans for the four major banks that use their own models as a basis for calculating minimum capital requirements.

“The increase in the risk weights, applying to all current and new high LVR loans for the major banks, will result in an average increase in capital held for housing of around 12 percent and will take effect from 30 September 2013. “With regard to the new macro-prudential policy, the public consultation has provided useful feedback on the costs and benefits of the proposed framework and on the potential effectiveness of the various instruments. Overall, we do not envisage major changes to the framework proposed in the consultation documents. Over the next two months, we will be consulting further with the banks to establish the implementation details of the various instruments so that we are able to use them as necessary.”

Mr Spencer said that the Reserve Bank is also strengthening regulation in a number of other areas, including OBR pre-positioning, a review of the Bank’s oversight of the payments system and the implementation of a new prudential regime for the insurance sector.

(Updated with comments from new conference)