Following the Global Financial Crisis, there was considerable international focus on reducing risks to the financial system. This led to the development of a policy approach known as macro-prudential policy, which uses prudential instruments to manage the system-wide (systemic) risks that can develop during boom-bust financial cycles. Macro-prudential policy aims to promote greater financial system stability by:
- building additional resilience in the financial system during periods of rapid credit growth and rising leverage or abundant liquidity; and
- dampening excessive growth in credit and asset prices.
A short video "Booms, busts and the way between" explains the role of macro-prudential policy and the tools the Reserve Bank has to smooth out boom-bust cycles.
Memorandum of Understanding on Macro-Prudential Policy
In May 2013, the Minister of Finance, Hon Bill English, and Reserve Bank Governor, Graeme Wheeler, signed a Memorandum of Understanding (MOU) on Macro-Prudential Policy. The MOU outlines the governance arrangements for the use of macro-prudential tools that are designed to promote greater financial system stability. The MOU sets out four macro-prudential tools in the New Zealand context:
- the countercyclical capital buffer (CCB)
- adjustments to the minimum core funding ratio (CFR)
- sectoral capital requirements (SCR)
- temporary restrictions on high loan-to-value ratio (LVR) residential mortgage lending.
Debt to income (DTI) limits
The Reserve Bank has suggested that serviceability restrictions such as DTI limits would be a useful addition to the tools allowed under the Memorandum of Understanding. If they were added and the Reserve Bank elected to enact them in the future, DTI limits would limit the share of residential mortgage borrowers able to obtain large loans relative to their income. In June 2017, the Reserve Bank consulted the public about this.
High loan-to-value ratio restrictions
Temporary limits on high loan-to-value ratio (LVR) residential mortgage lending were put in place in October 2013. High-LVR lending restrictions were changed on 1 January 2019, and vary depending on whether the borrower or tenants occupy the property.