The drums are beating for another RBNZ macro-prudential tool. Could it be some sort of debt-to-income ratio?

The drums are beating for another RBNZ macro-prudential tool. Could it be some sort of debt-to-income ratio?

By Gareth Vaughan

Will they or won't they?

The drums are beating for the Reserve Bank to introduce another so-called macro-prudential tool to try and rein in the hot Auckland housing market.

Finance Minister Bill English, who alongside Treasury, must be kept in the loop on any such Reserve Bank plans, last week hinted moves were afoot. English described comments from Reserve Bank Governor Graeme Wheeler in his  February 4 speech to the Canterbury Employers' Chamber of Commerce as making the case for further macro-prudential measures to slow Auckland housing inflation.

Chatter among economists has also been building.

Economists from ANZ, ASB and Westpac say they believe Wheeler may dip into his macro-prudential toolbox again this year following the October 2013 introduction of "speed limits" on banks' high loan-to-value ratio (LVR) residential mortgages. This is against the backdrop of Auckland house price inflation being seen as a financial stability concern, and an Official Cash Rate that, as my colleague David Hargreaves eloquently put it, is "looking increasingly sat on the shelf in terms of its practical usefulness."

So with Auckland housing inventory at its lowest level in more than eight years, fixed-term mortgage rate cuts seemingly coming every other day and strong Auckland house price inflation, what could be the Reserve Bank's next tool of choice if Wheeler does reach into his toolbox again?

The tool being touted among some economists, and by some in banking circles, is one that's not even in the toolbox at the moment.  It is some sort of debt-to-income restriction, perhaps along the lines of the one introduced by the Bank of England last year, which the economists at the New Zealand Institute of Economic Research (NZIER), in particular, advocate. This approach, NZIER says, directly targets the risk of whether people can afford to pay back their mortgage.

Another to highlight the potential for this type of tool was Auckland mortgage broker John Bolton, telling me in an interview last November that debt servicing was increasingly becoming an issue for borrowers. Not surprising given the size of some mortgages in a city where the median house price is $660,000.

In the UK no more than 15% of any lender's total number of new residential mortgages can be greater than 4.5 times the borrower's income.

Laying the groundwork?

The Reserve Bank has been doing groundwork that could, potentially, lead to the introduction of such a tool.

"We've been doing some investigations about debt-to-income, about debt service ratios, collecting more data," Reserve Bank  Deputy Governor Grant Spencer said when speaking at a press conference after the release of the central bank's Financial Stability Report in November.

"We're exploring this and these are the sorts of issues we talk about with the banks, overall lending standards and the criteria they apply," said Spencer.

He did add, however, that this wasn't something the Reserve Bank was concerned about, or was about to impose some sort of restriction on.

In a September submission to the Ministry of Business, Innovation & Employment on the proposed Responsible Lending Code, the Reserve Bank said the Code ought to establish that lenders should ensure borrowers will still be able to service mortgages if interest rates rise significantly. However, it also said a strict debt-to-income limit isn't an efficient way for the Code to make sure lending is being done responsibly.

In December Wheeler said the Reserve Bank wasn't considering introducing any further macro-prudential tools at that point.

But in his February 4 speech Wheeler said the Reserve Bank would be talking more about the housing market over the next few months.

"Our concern about house price inflation is based on the risk it poses to financial stability and the broader economy. Although it has not been a major factor in recent years, high rates of house price inflation can spill over into stronger spending and pressure on consumer price inflation. And the more that house prices get out of line with historic relativities, the greater the risk of a sharp correction, leading to financial instability," Wheeler said.

"Analysis by the IMF in 2013 indicated that New Zealand, along with Norway, had the greatest deviation in house price to income ratios from its historic trends among several advanced economies," added Wheeler.

He also said the central bank's main focus is on the Auckland and Christchurch markets given they represent about half the national real estate market, and are where the housing shortages are greatest and where market pressures are most intense.

"Auckland and Christchurch house prices are 39% and 27% respectively above their 2007 levels. House price inflation slowed as the loan-to-value ratio restrictions and the rise in mortgage interest rates helped to constrain demand, but appears to be increasing again in Auckland due to rising household incomes, falling interest rates on fixed- rate mortgages, strong migration inflows and continued market tightness."

" Annual house price inflation measured on a three-month moving average basis is currently 10.9% and 7.4 % in Auckland and Christchurch respectively, and 1.1% in the rest of New Zealand. We will have a clearer assessment when the February/March REINZ (Real Estate Institute of New Zealand) data is available," Wheeler added.

Given the Christchurch housing market appears to be sorting itself out after the tragic events of the earthquakes, a Bank of England style debt-to-income ratio appears an obvious tool to introduce to try and keep a lid on the Auckland market. 

Banks lending more than 7x annual income

In November's Financial Stability Report the Reserve Bank said: "Mortgage calculators suggest that banks are currently willing to lend up to a multiple of more than seven times annual gross income, at least for borrowers that have relatively high incomes."

It's safe to assume the majority of such lending is taking place in Auckland.

So if it wants to bring in a debt-to-income ratio, how would the Reserve Bank go about doing so?

Firstly, there's nothing stopping it adding a new tool to its toolbox, assuming English and Treasury acquiesce. And the central bank has also made it clear it could operate more than one macro-prudential tool simultaneously.

The Reserve Bank's 2013 macro-prudential policy framework lists "the case for incorporating debt-servicing capacity in to the macro-prudential framework" among areas not in scope for initial implementation, but that may form part of the Reserve Bank's future work programme. Incidentally, also included here is reviewing the economic case for and against the application of LVR restrictions on a regional basis. In theory that means the Reserve Bank could look at an Auckland specific LVR restriction. But to date it has not sounded keen on actually doing that.

Other tools

Aside from the LVR restrictions, the Reserve Bank already has three other macro-prudential tools in its toolbox. They are; the countercyclical capital buffer, which effectively is banks holding more capital during credit booms. Adjustments to the minimum core funding ratio, which could be increasing the amount of retail funding and longer-term wholesale funding banks have to use to fund their lending. And sectoral capital requirements, or increasing the amount of capital banks must hold against certain types of loans (IE home loans) in response to sector-specific risks. See more on all four tools here.

As illustrated below, there are various timeframes in place for the introduction of any of the existing four tools.

And, if we take Wheeler's comment about wanting to see REINZ's February and March sales data, then we aren't going to see an announcement on any new macro-prudential tool(s) until at least April. Perhaps the release of the Reserve Bank's next Financial Stability Report, on May 13, could be an opportune time for Wheeler to announce anything new on the macro-prudential front, if he's going to? And then there'd be a lead in, of several weeks or potentially months, before any new tool was actually introduced.

The announcement the LVR restrictions were being introduced was made on August 20, 2013, with them taking effect from October 1, 2013.  Well flagged by the Reserve Bank, the only surprise the banks seemed to get was that the LVR "speed limit" was set as low as 10%.

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Don't think a debt to Income ratio is a good idea. How will investors increase their income? Increase rents?

Remember the RBNZ has a separate plan afoot for bank loans to residential property investors that they don't consider a macro-prudential tool.
From a story last November - Deputy Governor Grant Spencer, said the central bank's still working on plans to make banks hold more capital against loans to owners of multiple rental properties. Spencer said the Reserve Bank is working on how to categorise a borrower as a residential investor, noting it could be based on the proportion of their total income that's coming from their investment portfolio, rather than just the number of houses they own.

GV. The multiple of 7x income loans in NZ is because of the RBNZ, not in spite of it!  Watch for some really delinquent act by the RB to debase the NZD, they (and their political masters) are desperate to facilitate a giant subsidy for fontera.

Oh for goodness sake , how on earth does the RBNZ ever intend to manage every homelaon in NZ , there are hundreds of soruces of finance available outside formal banks .
They are trying to deal with the symptoms when its the causes that must be addressed  

No R Meek.
They can reduce the ratio by lowering their debt level; or borrowing less if just starting out.

or not buy if it makes no sense except via a capital gain.

Correct steven.
I am always somewhat amused by people who complain about a ratio.
They often go on about one side of the ratio; yet seem to completely ignore a ratio needs two sides to work.

agree too, looks to me like another tool to shut first home buyers out of the market. Young people on modest incomes who struggle to even pull a deposit together. These will struggle to survive even paying JAFA rents, but will be better off if they at least put the equivalent of a rent payment into their own home.

Will RBNZ use Macroprudentials??? 
I think RBNZ don't know the real meaning of "MacroPrudentials"....
If RBNZ and the National Goverment is sincerely intent on ending the super Housing inflation in NZ, it only has to follow what the Singapore MAS, and Goverment has done to kill house price inflation....
Singapore has enacted "Macro Prudentials" to the extent that house prices now is back to 2008 levels...In some cases of High End Properties, they has fallen as much as 60%.
This is in an economic and political situation not unlike NZ of Neo-Liberal Capitalist thinking and governence.
The problem to our housing inflation is not "Macro Prudential" but Political Will !!! 

This is wrong on so many levels , in fact this is a  dumb decision.......... the WTF story of the week .
Banks must be forced to self govern lending practices, and manage their risks accordingly , and recognise that lending on property is not risk free .
If you restrict money supply , you need to recognise that human nature is such that when something is in short supply and they need it , they will find ways of getting it , whether it is food , water , shelter , sex , money , booze , drugs or anyting else
Like Robert Muldoons price controls  these will not work and furthermore, the RBNZ does not have the capacity to police the lending market .
A more dynamic approach is required instead of textbook RBNZ policy:-  
1) Firslty , we should have CREDIT REGLUATORY  laws like the UK and South Africa for Banks engaged in reckless lending to people who cannot afford it .
Over there , if you lend to someone without checking thier ability to pay , and  the borrower defaults and goes into administration and you cannot go to court if you lent recklessly.
2) Secondly , In an open economy , you cannot penalise citizens like this , and give an unfair advantage to those able to borrow offshore using family ties and syndicates .
3) Thirdly , AND THIS IS THE KICKER ......... Just how on earth does the RBNZ plan to manage everyone out there lending on credit , from GE ,  Noel Leeming , The Warehouse , Farmers , cash loan operations , Fuel Companies , credit cards , private placement lenders , etc etc .
You cant only regulate Banks , you need to ensure all credit providers are caught in the net .

Easy. Make all investment mortgages "non-recourse" loans where the borrower can walk away and send the keys back to the bank, like in many states in the US

Easy to force a bank to self govern - make loans non-recourse. See how much credit dries up when they have to properly value a house instead of passing the buck like they do now.

We need to deal with the root causes.  The poor old Reserve Bank is trying to deal with the failures of government.  The supply/demand equation is going backward.  This is urgent.  The government need to deal with the root causes
1 A hudge increase in the supply of land
2 A lot less bureaucratic barriers and costs
3 Deal to the corrupt building material supply cartels
4 A big reduction in immigration particularly while Kiwis are flocking home.  A lot more selective immigration control with meaningful follow up to ensure people are working meaningfully in their claimed skill areas.
5 Stop all foreign purchases of property.
The fact that Government are doing nothing meaniful to address the causes indicates that they don't want to and are very happy with things as they are.  Their present efforts are purely window dressing and mearly a fob off to public concerns.  English's claims that they can do no more is pure B.S.  The above are do-able if they had a will to do something meaningfull. 

If Robert Muldoon were alive he could explain to Mr Spencer , from first hand knowledge  what happens when you F()(@% - around with the markets to try and manipulate  prices .
His tool was called the  "price and wage freeze" , and  it was not fit for purpose .
LEARNING OUTCOME No 1: - Dont interefere  with pricing mechanisms directly
The market will turn around and bite you on the backside
You get in over your heads , and someone has  ball-aching job sorting out the mess you have created .
Interferance in a free market as large as our property market only worsens things and makes the problem too big to handle

I agree with you about Muldon.  He was a conplete idiot when it came to free markets.  He ran a bunch of policies were we borrowed ridiculously and promoted gross inflation from the perspective that this was ok and the inflation would make it easy to pay back the loans.  (disturbingly similar logic to a lot of property investors).  Of course it all got horibly out of control with 18 to 20 % inflation and interest rates to match.  In the end he paniked and as you say tried to regulate the free markets.  Most prices and wages were then controled by government decree.  When Labour took control, the ecconomy had effectively collapsed. 
Free markets are essential.  Unfortunately we do not have free markets due to the actions of corrupt building material manufacture and supply cartels, and councils that artificially restrain land supply.  It is one of governments prime responsibilities to ensure that all markets operately freely,transparently and free from monopolistic or cartel behaviour.  For example in a truely free market  you could buy any piece of land and build a house on it and the price of residential  land therefore would come close to the other competing use for it, i.e. farming.  (obviously from a town planning perspective you cannot go to complete freedom)  In a truely free market  you could import building materials from anywhere, free from the arttificial and highly protectionist restraints of BRANZ and import duties.  Ensuring that markets operate freely is in no way comparible with what Muldon did.  Quite the opposite.

What about having the restrictions on only where the problem is.  Auckland.
Different rules for different places.  ( and yes I do appreciate what that means about the border areas, and which end of the street etc etc)
But the problem is Auckland, so why stick the rest of us with rules not relevant.

No KH  Sorry Mate , you cannot subject Auckland to this .
What we do know is that LTVR policy tool has failed DISMALLY .
If it worked there would be no reason to bring another tool .
So now we bring out a new tool and wade deeper into the mess , and Mr Spencer will wade deeper and deeper until he gets in over his head ...........

Waddya mean Boatman "You cannot subject Auckland to this."
Actually it's Auckland subjecting the rest of us to it's problem.

KH even if I agreed with targeted controls ( I dont ) its too late. In the past week there has been confirmation of renewed interest in buying beach properties within a reasonable distance of Auckland and two respected real estate owners independent of each other have highlighted a recent surge in enquiry for property in Whangarei and Northland for example.With antedotal evidence of property that had been sitting around now getting multiple offers.
I don't envy the RB trying to find a solution that wont just make more money for accountants and lawyers as they find ways around the new rules. As for those advocating 'just let the market get on with it', the last time the banks were allowed to play without rules they werent the only ones to suffer. My farming business suffered as the cost of credit increased or became unavailable, like happened to so many other people around NZ.
In Australia the law meant our bank could only lend for farm purchase for a maximum of 15 years. This helped keep a lid on farm prices as even if the initial year was interest only to help get started the purchaser had to prove with budgets and cashflows that they could repay the mortgage within the 15 years. This quickly reduces the price to income ratio for anyone needing bank finance. 

Jeez , did those rocket scientists at the RBNZ not  do Eco's 101 at Uni ?
Interefere in a free market at your absolute peril .

It is not a free market. There is unfair competition and interference.

Limit lending to four times gross income. Sure it'll hurt for a year or so but in the long run it will be great for the economy.
All that would-be mortgage payment income will be spent and invested in the wider productive economy.

You realise what four times gross income is for much of New Zealand outside Auckland?

Lets say its $40k, so a house at $160k, outside of the main centres is that that crazy?

Gisborne, for example, has a household income of $45k before tax so this would allow a mortgage of $180k plus a 20% deposit this would be $225k. Median house price in Gisborne is $255k so no big difference.
Plugging the number into the banks websites, it looks like they would lend upto 7 times joint income so this would be a significant difference in somewhere overstretched like Auckland.

225k vs 255k when you're talking 45k for two peoples' working lives for a year. (or more accurately "a households gross income"

That's why I think a 1:4 isn't enough.  But that would depend on the interest rate.  If we were looking at interest rate in other countries (0 to 3%)  then 1:6 would be more appropriate.

If the properties aren't affordable the prices will fall to meet the market.

I dissagree. I believe that if the houses don't fetch a reasonable resale value they will simply be held onto as rental properties.

no they wont without anything to push them.  And since so few people buy with intent for profitable resale, its not like they need to mark it down just to move inventory....

"All that would-be mortgage payment income will be spent and invested in the wider productive economy."
Ok tell us what wider productive assets you could invest in with a deposit of say $50K?
A lawn mower round?
Or maybe a half share in a fish and chip shop?
And would the bank lend you 80-90% if you were short?

Good point. What would you invest in that was "productive"? Arguably, debt is one of the most productive assets of all in this day and age. So, if you have 50K, how about peer-to-peer lending via Harmoney? I know that 50K is an awful lot of disposable cash for the average NZer to have, but I wonder if the risk-reward with perr-to-peer is a good start. 

Absolutely, reduced reliance on bank "funny money" would be very positive.

Or provide equity to a business so it can expand overseas:

Unimaginative, but both suggestions are more productive than housing.
The bank wouldn't need to lend me 80-90%, this is where the concept of a "share" comes in as you alluded to in your fish and chip shop example.
Note that it's not just about investment, it's about spending too. With all that spare cash we would be able to spend more on enjoying and improving ourselves, cafes, bars, restaurants, shows, new cars, exercise, education etc. This would be fantastic for the country. 

Much hot air , the fact is we have a massive demand for housing from Immigrants , and locals with access to cheap money , and a City Council hell bent on making land as difficult as possible to acquire , by restircing supply and making it as expensive as it can through Levies , taxes , exhorbitant connection fees , etc

Waaay too much hot air.
Nothing will work (in our small market) if the problem is foreign money/buyers. Maybe the government wants the money that these buyers are bring in... Very short term thinking and typical of 'popular' politics.

Simplest method is to just ban interest only mortgages and make the payments based on a full repayment period of no more than 25 years. You couldn't get an interest only mortgage from a bank in the mid 1980's and banks would not permit payments on the P and I loan to exceed 33% of income. Most banks would also only lend 66% of purchase price or valuation, whichever was the lesser. We also had stamp duty payable at 1.5% of value of a house sale in the 1980's - that law is still in place and could easily be reactivated. Only place you could easily get an interest only loan albeit at a much higher interest rate, was from a solicitors nominee trust account and we all know what happened to those, with several lawyers ending up doing a stretch! So let's get real people it is the bankers inventive policies over the last 25 years that have got us to where we are now! A reality check required.

Second and third mortgages were also the norm.  at much higher rates than the first mortgage.

Step 1  Any tool that makes the speculators change their mind will start a small drop
Step 2 The run for the exit particularly among the non-residents and other similar will create an avalanche in Auckland.
Step 3 Lots of houses to buy for locals at more acceptable prices.

Some people have short memories. When I first went to the BNZ some 25 years ago and asked for a home loan they would only let you pay back 33% of your salary each week on a loan. Problem was even on what was a pretty good salary at that time for me would mean I still couldn't afford a home on a single income back then.They never even factored in the company car as a saving for me. Not sure when it all changed and I was able to borrow whatever I liked and ended up paying 80% of my salary on a home loan !!!!
Its a free market you choose to pay a Mortgage, get a flatmate and take a pass on all the "Toys" for 15 years or you pay rent for the rest of your life, get booted out of the place every couple of years and have potentially a big problem when you retire.

Not sure when it all changed and I was able to borrow whatever I liked and ended up paying 80% of my salary on a home loan !!!!
Maybe pretty much once the Australian's starting running the banks propper.
The slacker lending terms/credit expansion greatly improved business valuation (theirs), those things (NZ bank purchases) almost paid for themselves...
Back in the old days what the funding was for, was an intergral part of deciding the quality of the credit and approval. 
Now, it often almost seems the purpose seems private.

Never a truer claim made - total banks claims standing at ~NZD 371.610 billion are  irredeemable.