Reserve Bank of New Zealand Governor Dr Alan Bollard, in a speech at the Basel III Conference held in Sydney on March 25, said that the Bank was considering a number of tools to deal with future asset booms.
These may range from restricting home loans to home valuation ratio and a number of other measures designed to check expansion of credit.
During the last housing boom, the Bank was mainly using interest rate as a tool to cool down the market. Higher interest rates for foreign investors made the New Zealand Dollar attractive.
Exporters criticised the Bank after it raised the Official Cash Rate (OCR) to a record 8.25% in mid-2007 to counter a housing boom that was fanning inflation.
The New Zealand Dollar surged, as foreign investors were attracted to rising yields, curbing returns from overseas sales.
No silver bullet
Dr Bollard said he may implement further measures to dampen future asset and credit bubbles to maintain the stability of New Zealand’s financial system.
“While none would be a silver bullet in terms of moderating the credit cycle, we believe some could make a useful contribution,” he said.
There is currently considerable interest in macro-prudential instruments – policy tools that might be used to promote a more stable and resilient financial system and help smooth the credit cycle, reducing the risk of boom-and-bust cycles, Dr Bollard said.
These tools include restricting loan-to-valuation ratios (LVRs), allowing banks to lend not more than 80% of a property’s valuation and forcing them to hold set percentages of more expensive deposit-funding or longer-term wholesale funding. The extent of capital that banks are required to hold against loans on specific assets such as houses or farms would also be altered.
LVR restrictions could act as a brake on credit growth during a boom and have the advantage of being imposed and enforced relatively swiftly.
“The deployment of any tool would send an important signal to financial institutions, investors, rating agencies and the general public about the central bank’s uneasiness about rapid credit growth,” Dr Bollard said.
The Reserve Bank has forced lenders to reduce their reliance on short-term overseas funding by introducing its core-funding ratio.
Surging rates
This has seen unprecedented competition among banks in New Zealand to tap domestic investors, and driven up interest rates on term deposits.
According to the International Monetary Fund, the ratio is still too low, and should probably be higher than the current level of 75%.
Dr Bollard said the ratio has reduced the Reserve Bank’s need to lean so heavily on the OCR and has helped damp the attractiveness of the so-called ‘carry trade’ on the New Zealand Dollar, where investors take out low interest rate loans in one currency to park their fund in other nations with high rates.
This may also result in short-term wholesale interest rates not to rise as much and therefore reduce the attractiveness of the New Zealand Dollar to international investors seeking to take advantage of the relatively high interest rates New Zealand has had in the past.
“We do need to keep preparing for how we might deal with credit and asset booms when they recur in the future. We have identified several tools that we would contemplate using in the right circumstances,” Dr Bollard said.
Suresh Sharma is Director of Cherry Mortgage Solutions based in Auckland. His personal disclosure statement is available on request. He can be contacted on 021-827575. Email: cherrymortgage@xtra.co.nz
Website: www.cherrymortgage.co.nz.
