By David Hargreaves
Treasury has strongly hinted to the Reserve Bank that it should consider introducing debt-to-income ratios either alongside or perhaps instead of the current limits on high loan-to-value lending aimed at controlling the housing market.
When the RBNZ was earlier this year seeking submissions on its new Auckland-targeted LVR rules coming into effect from November 1, Treasury issued a detailed response, which has just been released under the Official Information Act.
While the paper ostensibly is a response to the RBNZ's LVR proposals it goes quite a bit further, outlining how Treasury sees itself working alongside the RBNZ. This may well be a response to the perceived friction between the two agencies over what Treasury saw as a lack of notice given to it when the proposals were originally announced.
In its paper Treasury says the rise in household debt in the 2000s was largely due to the rise in house prices and, to a lesser extent, changes in interest rates, "and the Treasury would agree with the RBNZ that this is a trend that requires further analysis".
"We would like to raise some initial points for discussion around how the credit story relates to macro-prudential policy," the paper says.
"The key aspect is that a rise in debt relative to income means an increase in the vulnerability of households in the event of a shock to income.
"There are a range of tools available for addressing this. LVR limits target one aspect of loan sustainability, that is, credit loss given default. Debt-to-income limits (DTIs) are an alternative macro-prudential tool that would offer an alternative or additional way of managing financial system vulnerability by targeting the likelihood of default.
"We appreciate that this is more difficult to implement in practice and that various technical issues meant that LVRs were chosen in 2013. We welcome the RBNZ’s work on DTI data since then, and look forward to the developments in this area."
The RBNZ view
Bernard Hodgetts, head of the Reserve Bank's macro financial department told Interest.co.nz's Gareth Vaughan in an interview in May after the LVR measures had been announced that the RBNZ was continuing to do work on the debt-to-income ratios of residential property owners - though it has given no indication it is planning any introduction of specific measures in that area.
Earlier this year economists speculated the prudential regulator may look to add a debt-to-income ratio tool, along the lines of the one implemented by the Bank of England, to its macro-prudential toolbox. but Hodgetts said in that May interview there were no current plans to do so, and there would need to be harmonisation of how banks measure debt-to-income ratios first.
"We've been asking banks to provide information on the debt-to-income characteristics of their mortgage lending and we've received some data from them on that. We're still talking to them about the data and the way they've calculated it, and the way various aspects are defined because different banks may calculate the income that goes into a debt-to-income measure differently," Hodgetts said.
"So you need to be quite clear that you're doing that data compilation on a consistent basis between banks."
The aim was to try and get a better handle on what the debt-to-income characteristics of residential lending look like.
"At this point we certainly have no plans for any debt-to-income type measures or anything of the sort. But we are looking quite closely at that aspect of lending, trying to establish the facts in terms of what might or might not be warranted or could be possible in that area," said Hodgetts.
However, it was possible the Reserve Bank may seek a uniform debt-to-income measure across all the banks.
"If you were looking for something in that arena you'd certainly want a degree of harmonisation around how banks were calculating these ratios in order to apply any kind of constraint. But it's far too early to be talking along those lines at this stage. We're really just collecting information, trying to understand what the data's telling us."
Treasury's 'challenge function'
The Treasury paper goes on "in the spirit of fulfilling the Treasury’s challenge function", to suggest to the RBNZ it looks at the following ways of improving the ongoing policy-making on macro-prudential policy:
- Providing a more detailed problem definition and rationale for proposed macro-prudential interventions
- Improving clarity of RBNZ policy communications of the channels the proposals are targeting and the expected impacts of the policy
- Providing additional evidence and analysis on a number of issues where possible, and continuing to develop the evidence base for the policy. This should include substantial analysis of the ongoing effects of previous policy settings
- Overall taking a more proactive and forward-looking stance to macro-prudential policy settings, such as setting out and maintaining evidence on the key indicators for risk, which might include some form of forward policy guidance on the potential medium-term policy direction. This relates to the proposed adjustments to the temporary LVR policies, and would help support credibility and reduce market uncertainty
- Relating policy proposals to the stress testing of banks, to increase the emphasis on the direct stability impact of the proposals.
The paper says that In the Treasury’s view, the delivery of the RBNZ’s financial stability mandate and effective use of macro-prudential tools "will be more effective and better understood" when the RBNZ coordinates with the Treasury to ensure overall coherence in the signals that are sent to the market.
"The Treasury has two key roles in this regard. First, it is responsible for the overall macroeconomic framework. Macro-prudential policies are an important part of this framework, and we have a clear interest in ensuring that the objectives of these policies support the broader macroeconomic framework. In addition, Treasury has a responsibility to ensure that institutional arrangements appropriately reflect Ministers' views and interests where possible.
"The ongoing involvement of Treasury on macro-prudential policy is desirable as the Crown faces large externalities arising from failure to mitigate systemic risk, and as macro-prudential policies form part of the overall macroeconomic framework for which Treasury is responsible. The Treasury’s role, however, should not compromise the operational independence of the RBNZ. At the same time, greater transparency and accountability will ensure higher quality decision making and is in the interests of both the Treasury and the RBNZ," the paper says.
Referring to credit issues, the Treasury paper says Treasury would "encourage" the RBNZ to provide further detail on the indicators they think are of relevance to financial stability, "and to provide a more forward-looking analysis".
"For example, what would sustainable levels of household debt might be in the New Zealand context, and therefore what rates of net and gross credit formation would be tolerated, and what might present a cause for concern and justification for action."
Talking specifically about the new investor-targeted LVR proposals, the Treasury paper says the RBNZ consultation document issued earlier this year "could be clearer on the magnitude of the problem that investors pose and how this might impact on the banking system, for example the potential loss given default from the investor sector".
"We acknowledge that it is a complex issue to unpick and is made more difficult by the lack of evidence and data around this topic.
"We would like to encourage the RBNZ to continue to work on the relative stability risks of investors to add to the evidence base. This could include more analysis of international experiences, including identifying similarities and differences to New Zealand’s situation."
The Treasury paper notes that the growth of investors among Auckland mortgage holders "could be a result of removing a proportion of first time buyers from the market, intensifying the concentration of a risky set of borrowers".
"This may be an unintended consequence of the 2013 LVR policy settings, underlining the importance of carefully considering the potential impacts of any change to policy."
The paper says Treasury recognises that macro-prudential policies have a distortionary effect on markets, including impacting on the ability of first time buyers to enter the market.
"However, we do not see that these distortions currently justify relaxing the LVR limits in the rest of the country." This is a restating of an earlier warning issued by Treasury.
Since that time there have been marked signs that the heat in the Auckland market is starting to spread elsewhere and the RBNZ has more recently cautioned that if this trend continues it may delay the proposed phasing out of LVRs outside of Auckland.
The Treasury paper says the relaxation of the LVR policy outside of Auckland, also taking effect on November 1, "sends a confusing policy message".
It says that looking forward to possible future macro-prudential settings, the Treasury would like to highlight that "there is a trade-off between the policy being more targeted and the additional complication that this entails".
"The number of classifications and exclusions are growing (Auckland/rest of country, investors/non-investors, new buildings/existing buildings), detracting from the simplicity of the original policy and requiring more resource on the part of buyers to understand and banks to administer the policy. We appreciate, however, that this is new territory for both the RBNZ and the Treasury and we will need to work together to ensure that we continue to develop our understanding of these policy settings."
The paper says it "would be useful" for the RBNZ to set out possible indicators or reasons for further LVR action over the medium term (whether tightening or relaxation) and avoid policies appearing reactionary.
"This would send signals to the market on the RBNZ’s intentions, and would help the market set expectations. This itself would help support stability in the market, and would be of significant value.
"The Treasury would like the RBNZ to set out what path might provoke them to continue releasing the limits, or would lead to a reimposition. Further, Treasury would also encourage the RBNZ to take more of a medium-term view of possible policy options. This could involve identifying specific indicators that are relevant to the decision making process, and how the RBNZ expects them to evolve over time."