Opinion: The Reserve Bank's taking some sound and pragmatic steps toward, perhaps, saving the banks from themselves on housing lending

Opinion: The Reserve Bank's taking some sound and pragmatic steps toward, perhaps, saving the banks from themselves on housing lending

By David Hargreaves

If it carries on like this the Reserve Bank is in serious danger of developing some real teeth.

While the big banks probably have no visible bite marks at this stage, they are unlikely to be thrilled by the contents of the latest RBNZ consultation paper: Review of bank capital adequacy requirements for housing loans and internal models processes.

The latest paper comes hard on the heels of the RBNZ's decision to introduce "speed limits" on high loan-to-value lending (LVRs) from October 1.

It is becoming clearer and clearer all the time the extent to which RBNZ Governor Graeme Wheeler has been left affected by his experiences of being in the US during the big housing bust of 2007-08.

International warnings

The international warnings about the New Zealand house market being over-valued and the extent to which that is potentially a problem for our banks have been well and truly taken on board, oh yes. There will be no banking stability problems on this Governor's shift, oh no.

I was, and remain, sceptical about the imposition of the LVR limits in relation to the current rising housing market. I still think the LVR limits will encourage individuals to undertake risky financial behaviour, which could have very bad consequences for people on a personal level.

I also think that some of the measures suggested in the latest discussion paper may make those potential problems worse.

Credit due

But, credit where it is due, a lot of the latest proposals look like good commonsense 'belts and braces' measures that will force the banks to be prudent.

Now, banks will always say they are prudent. But history suggests they can and do get carried away at times of asset bubbles.

The key points in the consultation paper are contained in this article by Gareth Vaughan, so I won't reiterate them in detail. What I will do is add some hopefully constructive views on the main issues, which I subjectively identify to be:

  • A proposal that the big four banks are treated the same way as the smaller banks in that all credit - including personal loans and credit cards - that is secured against a house, be included in the LVR calculations.
  • The move that all banks be treated the same, in that they will all be required, as opposed to just presumed, to have a property valuation policy and that this policy is not affected by market conditions.
  • That the banks provide details on how they account for such situations as borrowers with more than one property secured, or indeed where there are multiple borrowers with multiple properties.
  • That mortgages where the borrower owns more than four residential properties are treated as commercial loans, and likewise in some circumstances borrowing on lifestyle blocks may also be treated as commercial loans. This would make a substantial difference in the "risk weighting" given to the loans.

I like the information gathering that is implied by particularly the third point. It will indeed be most useful for the RBNZ to not only know how banks account for such lending, but how many loans are affected. 

There may well be considerable work involved at bank level in giving this information, but it should be worth it.

Why not before?

Hindsight is a splendid thing, but you do wonder why such information has not been gathered before. Although, I suppose the RBNZ might argue that it is now gathering this information in order to apply a new policy - IE the LVR limits - and previously it might have been seen as a waste of taxpayers' money if the information was not seen as serving a specific purpose.

But for me, I think the more information we have on the inside of the NZ housing market the better. 

A lot of the talk on the heated Auckland market focuses around the shortage of supply - but there is no really good information on just who is buying, why and how they finance their purchases. Better understanding of what makes the house market tick is vital.

In the same vein it will also be very useful for the RBNZ to be gathering information on how many people are property investors and how many properties people are owning.

Abundant sense

To me it makes abundant sense that anybody owning as many as five houses is in fact a professional investor and therefore should have their loan or loans treated as commercial loans. That should have two significant impacts. 

First, of course the different tagging of the loan makes a huge difference to the "risk weighting" applied to the loan as an asset and therefore implicitly on how much capital the banks need to hold. At the moment the "risk weighting" given to the big banks on mortgages is only about 33% and around 38% for other banks such as Kiwibank.

With commercial loans of course, 100% of the loan is included in banks' capital adequacy ratios. So, quite a difference.

The second point is, what will the re-tagging of the loans as commercial from residential mortgages do to the cost of funding for investors? Potentially, quite a lot, you would have thought.

Unintended consequences

Of course, it is to be presumed if this change goes ahead that we can expect to see the wives (in their own names) and children (in their own names) and cousins etc of people who own five or more houses suddenly taking ownership of properties. So, this is one area in which there may be those dreaded unintended consequences. Whether the RBNZ has some grand plan to avoid that, time will tell.

I give the RBNZ great credit for thinking of the fiendish policy around valuation of houses, though it is likely to be problematic to police.

Having houses regularly revalued when the market's going up is one ready way the banks could quickly move customers out of the high LVR bracket.

If for example a couple with a $60,000 deposit bought a $500,000 house in Auckland they would need a high LVR loan of some 88% of the money.

Move on a year and if the Auckland market went up another 10% (and it's been rising faster than that recently) then the house would be worth $550,000 and our couple would now magically have equity of $110,000 and their loan is but 80% - IE not high LVR.

On this policy the RBNZ proposes this:

“Property value is the value of the residential property determined under a bank’s residential property valuation policy when a residential mortgage loan is originated”.
 
“A property valuation policy means a policy governing how a property value is determined for a residential mortgage loan that - (i) is approved by a bank’s board of directors; (ii) includes the requirement that only property valuations by independent valuers are used for the purpose of calculating the loan-to-value ratio; (iii) includes guidance on the use of the purchase price of a residential property; and (iv) ensures that its application is invariant to the direction of the movement of residential property prices, i.e. it is applied symmetrically irrespective of whether residential property prices are increasing or decreasing.

“independent valuer means a person who is not associated with a person who has an interest in the residential property for which a valuation is made and who is: (i) a registered valuer as defined in the Valuers Act 1948; or (ii) another person approved to provide valuation services by rules made under the Rating Valuations Act 1998:” 

The bold lettering is mine and highlights the nub of the issue. 

The RBNZ wants to avoid banks coming up with spurious excuses to revisit mortgages and get them recategorised as non-high LVR loans during fast-rising property price periods.

Some arguments

I can see this causing some arguments. It sounds good. But in reality it would be difficult to avoid a bank coming up with a feasible excuse to revisit a mortgage if that bank thought the house value had gone up.

But an interesting flip side is that banks would need to be careful in what they say about their valuation policy, because if it was written in stone that a bank would have a house revalued every year - and the value had gone down - well, unhappiness all around. A non-LVR loan could magically become one.

What will they make of it?

What the banks make of all this will be interesting to see.

It can be expected there will be carping about amount of work involved and potential extra costs to consumers. And in reality they will probably be right - some of this stuff looks like it will make banking more expensive for the customer. But maybe we have to pay that price.

In general I do applaud the RBNZ's efforts to add greater stability to our financial sector and indirectly, perhaps, to gain some better measure of control over the potential boom-bust nature of our housing market.

 

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?

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17 Comments

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It is becoming clearer and clearer all the time the extent to which RBNZ Governor Graeme Wheeler has been left affected by his experiences of being in the US during the big housing bust of 2007-08
 
He needs to exercise his authority more rigourously if he is to overcome local outbreaks of the banking behaviour deficits underpinning recent developments he must have noted in the US.
 
The Credit Bubble Is Not Only Back, It Is 94% Bigger Than In 2007 Read more
 
 

He needs to exercise his authority more rigourously
 
Agreed and think what a career coup this would be to be seen to tame the 'four pillars' from across the ditch. Going after the big sharks from the small pond. 
:-) 
 
Great sport, I say!
 
Watch our politicos try and kneecap him again.

And here we have Cunliffe first out of the blocks on that score;
 
However, Labour Party leader David Cunliffe is already campaigning for the home buyer vote, saying he will ignore the Reserve Bank's policy if he is in power and exempt people trying to purchase their first home.
"At least in an interim basis while we're shaking down KiwiBuild and the capital gains tax yes that would be our approach," he said today.
 
http://tvnz.co.nz/national-news/majority-voters-oppose-new-loan-restrictions-poll-5589650
 
 
 

So, let me get this right, he thinks they should have done what John Key wanted them to and has no regard for the independence of the RBNZ from political interference. Muldoon would be proud. A dictator in a cloth cap?

Yep....pretty much sums up the vote buying thats intended....so much for making hard decisions and choices....no spine at all....
Actually I think Muldoon did have some spine....he made some decisions....unlike this lot...I odnt think Muldoon deserves such an insult myself.
regards

The reference was chosen because it shows a complete lack of respect for the opinions of others. It suggests an intellectual arrogance,  bright people make bigger mistakes but less frequently.

David.   "I still think the LVR limits will encourage individuals to undertake risky financial behaviour, which could have very bad consequences for people on a personal level."
How so?  Surely the previous 100% loans encouraged very risky behaviour.  On a mass scale as well. 
 
 
 

True enough. But the homeowner was borrowing 100% at bank interest rates. I guess the danger with the LVR limits is that people will beg, borrow and whatever sums of money - possibly at prohibitive interest rates - to make up a deposit. There will be little transparency - IE the bank won't know the true picture. And it could be disastrous for the borrower. So, the LVR limit removes risk from the banks but could potentially drive people to more dangerous behaviour than simply borrowing 100% from the bank. Now, you might say: "Silly people." And I would agree. But rationality seems to fly out of the window when some people want to buy a house. Regards

While true some "silly people" will try this sure, most will not.  If or when the borrower doing these games gets caught out, then the borrower will be in deep doo doo....I hope. 
"So, the LVR limit removes risk from the banks" yes and thats the idea, if we have a tiny % of stupids then their gross failure wont effect the integrity of our economic/financial system...which is the whole idea.
regards

Rather than getting exercised about the first home buyer, maybe the reserve bank should take firm aim at property investors/speculators.  The RB could require the banks to progresively raise the LVR limit on investment houses from the present 20% to 60 % over a period of 3 years.  At one stage banks required higher equity in non residential investment properties.  

Yep, it has to be on first time buyers as that is the numbers and the start of the leverage escalator.
regards

I doubt your 20,000 figure.  If there are 200,000 first home buyers out there, then they must be living somewhere that they do not own and therefore are presumably renting.  That would make at least 200,000 rental houses, probably a whole lot more.  What is the current rate of home ownership in NZ?  68%  That means 32% of the houses are owned by an investor who would be affected by my proposal.  It would therefore have a very significant effect.

Chris - M  - you would need to take into ocnsideration a lot more facts than what you have presented. How many Companies or other business entities own 32% of that housing stock your talking about?
 
You can't use that 32% figure and then make assumptions that the 32% are investors.
How many Trusts or Companies own homes to house workers or themselves? even rural schools own houses for teachers so are these schools now investors? Those living in the houses of Trusts and Companies are required to pay market rents.
 
If I have a trust which owns a house and I own no property as I have placed it in a Trust then I would be among the 32% of people who don't own a home.
Home ownership figures are not really a good way of ascertaining exact information as there are far to many variables that can occur.
 
Take your example of 200,000 FHB what percentage would be couples that could be in that figure? Then think about student flat type accommodation it's temporary while the student is studying but these people could be considered FHB. There are far too many anomolies to pigeon hole people into groups and if you do you chance damaging their futures by implementing something that could have a detrimental affect upon them. That is why the free market works best. Business and investors identify where the shortages or issues are and resolve those issues. Got to get rid of the impediments which Boatman lists below and the likes of Hugh P who extensively writes on this topic.
 
If the impediments aren't removed then house prices will keep escalating and none of us want to see people with enormous mortgages around their necks for life.
 
 

A free market would be great if we had a free market.  But we don't.  The supply of land is artificially constrained by corrupt municipal authorities and the building material supply market is a monopoly/duopoly set up that the government turns a blind eye to.  (We must be "supportive" of industry is the mantra that goes round Wellington)  The reality is that this so called free market aint working and certainly not in the interests of those who are most vulnerable.  If you claim what is happening in the housing market is evidence of how a free market should work then the case  is disproved because it is in a very bad way and getting worse.  So strong changes are required.

Chris-M  - I think it is better to remove all the distortions that don't make it a free market. If you intervene in the market as you have suggested by targeting investors and speculators you cause other problems.
 
As I have said in previous posts everyone who participates on the interest.co.nz site wants affordable housing for NZ'ers. Many of us already know where the distortions are. Many of us understand financial stability. I think there have been many quality posts in regards to rectifying the problems. If the posters on this site have the ability to reach consensus through understanding the issues then maybe we can live in hope that the Politicians and bureaucrats can pull their horns in and address the issues swiftly and let everyone move on.
 
 
 

THIS IS NOT A BUBBLE ! This is not 1987  or 2007 .
So stop referring to it as a bubble .
Its an Auckland and Chch  phenomenon, for divergently diffrent reasons
The increase in Auckland house prices is driven by real demand for housing by migrants, people from Chch and FHB's ,  an artificial shortage of sections due to limits on Auckland  , council fees for subdiviions that are a rort , collusion or monopoly pricing activities by builders merchants , and cheap money.