By David Hargreaves
The Reserve Bank has gone into full reverse over plans to force the country's big four banks to include personal loans and credit card debt in their loan to value ratios (LVRs) on residential lending.
And not only has the RBNZ yielded to lobbying from the big banks on the issue - but it has now done a complete u-turn and freed up conditions for smaller banks, such as Kiwibank - which were previously obliged to wrap personal loans and credit card debt up in the LVR calculations.
The major back down from the central bank was contained among three documents it issued just prior to Christmas, including a consultation paper on the RBNZ's abrupt about-turn late last year to allow new house builds to be exempt from the so-called "speed limits" on high LVR lending.
The RBNZ said it had carefully analysed points raised by submitters, including seven submissions from banks and four from "other stakeholders" and "reconsidered its policy position".
'Persuaded by submitters'
The central bank said that in terms of its objective to establish a common approach for calculating LVRs for both the big four banks and the others, "we have been persuaded by the arguments of submitters".
As such, the RBNZ would now "harmonise" industry requirements for all banks based on the capital requirement rules for the big four banks.
In other words the big banks keep what they have now and the other banks, such as Kiwibank, get a freeing up of rules.
The RBNZ said the decision "means that most unsecured loans such as credit card limits or personal loans do not have to be included in the loan amount when calculating the LVR of a residential mortgage loan".
It said the exception was when the terms of a personal loan or credit card were directly linked to a mortgage on residential property. An example of this would be a credit card that was contractually tied to a customer’s mortgage loan and was effectively an extension of the mortgage.
The RBNZ said it would also take into account the suggestions made in the submissions to it and would deal with potential LVR restriction avoidance issues under its document that sets out the framework for restrictions on high LVR lending.
"This may include additional reporting of information to the Reserve Bank or depositor verification requirements. It should be stressed that revisiting the proposal to include unsecured lending in the LVR calculation or having a separate definition that includes it in [the LVR framework document] remain options should the Reserve Bank detect any avoidance activity or non-compliance with the spirit of the LVR policy."
The RBNZ said it would "discuss transitional arrangements to the new requirements" with banks.
The original proposals from the RBNZ came in the run-up to the introduction of the LVR speed limits on October 1 last year.
In late September the RBNZ issued a consultation paper titled: "Review of bank capital adequacy requirements for housing loans and internal models processes".
Among several fairly hard-hitting proposals the RBNZ outlined plans to extend the rules under which the smaller "standardised" banks operate now to the big four banks, which are known as "internal models" banks.
The context to this is that the big four banks - ANZ, ASB, BNZ and Westpac - use what's known as the internal model, where they build their own models to calculate their regulatory capital requirements and must then get them approved by the Reserve Bank. All other banks, including Kiwibank, run what's known as the "standardised" approach where the Reserve Bank prescribes their regulatory capital requirements. Allowing the big four to run the internal model approach is in line with international guidance from the Basel Committee on Banking Supervision.
So, it was the RBNZ's intention to have all the banks brought into line with the tougher rules currently applying to the "standardised" banks.
Supporting LVR policy
In one of the papers released just prior to Christmas, and which summarises submissions received on the consultation paper as well as the subsequent policy decisions made, the RBNZ said that the main reason for the proposal to align the big four banks with the others was to support the LVR policy.
"A further consideration was that under the common 'all obligations' mortgage banks take security over the residential property, which they can then enforce for any claim they have against the borrower. For internal models banks, that would have meant including unsecured lending such as, for example, credit card limits or personal loans in the definition of the loan amount. Standardised banks already have to include those unsecured loans in the LVR calculation.
"The proposal would have met the Reserve Bank’s objective of having a consistent definition across the two sets of requirements, and reduced the scope for avoiding the LVR restriction by taking out personal loans or borrowing on one’s credit card as a substitute for mortgage borrowing. Theoretically it would have also reflected the economic substance of an all obligations mortgage, assuming that banks could enforce the all obligations mortgage for the purpose of recovering other loans."
The main objection to the Reserve Bank’s proposal from the big banks was that credit card and personal loans were already treated as unsecured lending and as such given a risk weight accordingly. Their inclusion in the calculation of the LVR would lead to a form of “double counting” and not reflect the way these loans are treated by banks. Internal models banks estimated that the impact on risk weights for housing loans would be in the region of 0.5% to 0.6%, the RBNZ paper said.
Several submissions to the RBNZ expressed a concern that the inclusion of unsecured lending in LVR calculations could lead to customers splitting their banking services across multiple banks and that banks "would lose their single customer view".
"This, it was argued, would make lending to customers more risky, and actually not achieve the objective of reducing the avoidance potential of the LVR policy."
The RBNZ paper said that "internal models banks" had also argued that the inclusion of unsecured lending in the LVR calculation would necessitate changes to internal models and IT systems and staff retraining.
"Those banks opposed to the inclusion of unsecured loans in the LVR calculation generally accepted the Reserve Bank’s objective of minimising the scope for avoidance of an LVR restriction. However, some banks suggested that objective could be achieved by other means."
Suggestions included the obligation on banks to abide by the spirit of the LVR policy, and the proposal that the Reserve Bank track the development of other loan commitments by extending the reporting requirements under the framework for restrictions on high-LVR lending.
Loans for investors
The RBNZ's original consultation document back in September had also proposed changes to the way loans for residential property investors were treated.
It proposed that if a bank had recourse to four or more dwellings owned by the borrower, then the loan "could no longer be classified as a residential mortgage loan".
After submissions, this has now also been amended, with the figure increased to five or more dwellings.
The RBNZ in its pre-Christmas paper said there was "general agreement" that further clarification on the boundaries between asset classes would be useful.
But some submitters pointed out that the definition of four dwellings was "insufficiently precise" and that an investor could have more than one dwelling on a single title, e.g. units or flats.
"A few [submitters] argued that drawing the boundary at a specific number would encourage customers to split their borrowing across more than one lender, potentially limiting a bank’s ability to assess the customer’s credit risk and increasing overall risk, and disadvantage borrowers with considerable other income which makes repayment of the mortgage not dependent on the rental income those properties generate."
The RBNZ said it was increasing the "count threshold" to five properties and greater clarity would be provided as regards the treatment of multiple dwellings within a property.
"The Reserve Bank is of the view that anyone with more than five properties, regardless of whatever other income sources or revenue streams may exist, should be treated as running a small business. To avoid further confusion, this would mean treating those loans as corporate property loans."
Regarding the consultation paper on the proposed modifications to the LVR policy to allow exemption for new builds, submissions from interested parties are open till February 14.
The RBNZ said that although a "compelling case" had been made for exempting construction lending from the LVR speed limits, "the available evidence does not point to any further broadening of the exemption framework in the foreseeable future".