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Lending ratio imposes speed limit on mortgages

The Reserve Bank of New Zealand (RBNZ) recently announced restrictions on high loan-to-value ratio (LVR) lending.

The restrictions take the form of a ‘speed limit’ that requires banks to restrict new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new residential mortgage lending.

The speed limit on high-LVR lending is designed to slow the growth in house prices and housing credit, and mitigate associated risks to the financial system and the broader economy.

Prudential tools

LVR restrictions are one of the four tools that make up the Reserve Bank’s new macro-prudential toolkit, and this was the first intervention under its macro-prudential policy framework. Borrowers with LVRs of more than 80% (less than 20% deposit) are often stretching their financial resources, and are more vulnerable to an economic or financial shock such as a recession or an increase in interest rates.

The imposition of LVR restrictions was a significant development in the way RBNZ applied its longstanding regulatory powers, driven by escalating concerns about the housing market.

Over-valued stock

Housing lending makes up more than half of all lending by New Zealand banks, and surging house price growth (particularly in Auckland) was judged to be contributing to an increasingly overvalued housing stock.

This leaves borrowers and banks exposed should house prices suddenly fall. Given that well over half of New Zealand household wealth is held in the form of housing and that household indebtedness was already running near record highs, the ability of an indebted household sector to withstand a major decline in house price was a serious concern.

Potential damage

Although the financial system is currently well positioned, a much-extended house price boom that ended in a severe housing downturn could cause substantial damage to the financial sector and the economy.

As the prudential regulator charged with maintaining soundness of the New Zealand financial system, RBNZ was faced with a difficult choice.

Should it intervene to take the heat out of the housing market, and if so, what would be the right form of intervention?

With escalating house prices threatening financial stability but inflation running below the middle of the Bank’s 1% to 3% inflation target, LVR restrictions were considered to offer the most appropriate response.

The background

The Global Financial Crisis (GFC) prompted central banks and prudential regulators to reflect on the best way to safeguard financial stability.

‘Macro-prudential policy’ has since developed as a significant new policy function in many countries, with increased use of LVR restrictions.

Prior to the GFC, LVR restrictions were mainly used in emerging market countries and some Asian advanced economies.

Since the crisis, LVR restrictions have spread beyond this group and are now being used in Canada, Sweden, Finland, Norway, Israel and, recently, New Zealand.

Lamorna Rogers is Advisor, Macro-Financial Stability at Reserve Bank of New Zealand based in Wellington. The above is an extract from an extensive document prepared by her for the Reserve Bank of New Zealand Bulletin. For full text, please visit www.rbnz.govt.nz

Position as at April 4, 2014

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