Limits for high-LVR mortgage lending
Banks will be required to restrict new residential mortgage lending at LVRs of over 80 percent to no more than 10 percent of the dollar value of their new housing lending flows.
In a speech today at Otago University, Mr Wheeler said: "Housing plays a critical role in our economy. It represents almost three quarters of household assets, and mortgage credit accounts for over half of banking system lending. Housing is a major source of value and of risk to the household sector and the banking system.
"The Reserve Bank is concerned about the rate at which house prices are increasing and the potential risks this poses to the financial system and the broader economy. Rapidly increasing house prices increase the likelihood and the potential impact of a significant fall in house prices at some point in the future. This is particularly the case in a market that is already widely considered to be over-valued.
"House prices are high by international standards when compared to household disposable income and rents. Household debt, at 145 percent of household income, is also high and, despite dipping during the recession, the percentage is rising again. Furthermore, the growth in house prices is occurring after only a small correction following the house price boom of 2003-2007 that saw New Zealand house prices increase more rapidly than in any other OECD country.
"The Reserve Bank is not alone in expressing these concerns. Over the past several months the IMF, OECD, and the three major international rating agencies have pointed to the economic and financial stability risks associated with New Zealand's inflated housing market.
"The LVR restrictions are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy.
"The conventional mechanism to help restrain housing demand, while working on the supply response, would be to raise the Official Cash Rate (OCR), which would feed through directly into higher mortgage rates.
"However, while higher policy rates may well be needed next year, as expanding domestic demand starts to generate overall inflation pressures, this is not the case at present. CPI inflation currently remains below our 1 to 3 percent inflation target. Furthermore, with policy rates remaining very low in the major economies, and falling in Australia, any OCR increases in the near term would risk causing the New Zealand dollar to appreciate sharply, putting further pressure on New Zealand's export and import competing industries.
"In the current situation, where escalating house prices are presenting a threat to financial stability but not yet to general inflation, macro-prudential policy offers the most appropriate response," Mr Wheeler said.
"The Reserve Bank considers that LVR speed limits will be more effective than other macro-prudential tools in constraining private sector credit growth in the housing sector, and dampening housing demand. Other macro-prudential instruments, such as counter-cyclical capital buffers and capital overlays on sectoral capital requirements, are likely to have less effect on the demand for housing-related credit and on house price growth.
"We are concerned to ensure that specially designed lending products are not developed with the purpose of avoiding or undermining the LVR restrictions. The Reserve Bank expects bank senior management and bank boards to respect the spirit and intent of the LVR restrictions and to closely monitor the level of high LVR lending.
"How long LVR restrictions may remain in place depends on the effectiveness of the measures in restraining the growth in housing lending and house price inflation. LVR limits will be removed if there is evidence of a better balance in the housing market and we are confident that their removal would not lead to a resurgence of housing credit and demand," Mr Wheeler said.
"It is critical that priority be given to implementing measures needed to relieve the shortage of housing and land supply, which is the dominant cause of the increase in house prices in Auckland and Christchurch. But the LVR restrictions have a useful role to play alongside the supply measures."
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The Reserve Bank's interest in housing
There are three main reasons for our current focus on the housing market:
- The possibility of a significant fall in house prices can have important implications for the financial sector and the broader economy.
- The housing and the construction sector can be a source of
inflationary pressure if construction costs and rents increase and the
‘wealth effects' of rising house prices feed through into additional
spending or borrowing to finance consumer goods.
At present, rising construction costs are not a major concern for monetary policy. While construction costs in Christchurch are up 12 percent over the past year and they have recently been rising in Auckland, changes in relative prices are needed to attract additional resources into the construction sector. The Reserve Bank will continue assessing the risk of spill-over of these prices into more generalised inflationary pressures.
- Declining house prices can have significant impacts on output and employment, especially when the associated de-leveraging of household and corporate balance sheets continues for several years.
The case for LVR restrictions
The LVR restrictions announced today have a useful role to play alongside work being done by other Government agencies, local councils, and the private sector to increase the supply of housing. Initiatives such as the Auckland Accord, and measures to increase the availability of land zoned for residential housing, and to raise productivity and lower costs in the building sector, are important for increasing housing supply.
However, it is likely to take considerable time for the supply/demand imbalance in the housing market to correct through supply side measures alone. In the absence of demand measures, house prices might continue to rise rapidly and pose an increasing risk to financial stability.
An eventual increase in supply and the more immediate impact of LVR restrictions announced today can both help reduce the risk of a house price boom ending in a severe housing downturn that causes substantial damage to the financial sector and the economy.
Provided loan-to-value restrictions help to dampen house price inflation, they will also assist monetary policy. As such, they increase the flexibility available to the Reserve Bank in determining the timing and magnitude of future adjustments in interest rates. This is not the primary reason for the policy, but could be valuable given the ongoing highly accommodating monetary conditions in international financial markets.
How LVR restrictions will work
Some loans will not count towards our measurement of the speed limit for banks. These include Housing New Zealand's Welcome Home Loans, bridging loans, refinancing of existing loans and high–LVR loans to existing borrowers who are moving home but not increasing their loan amount.
Allowing for these exemptions, we estimate that the 10 percent speed limit will effectively limit the banks' high-LVR lending flows to about 15 percent of their new residential lending.
We will monitor closely the impact of LVR restrictions and report on their impact in the Financial Stability Report that we publish every six months.
Banks commonly issue mortgage borrowers with pre-approvals, which represent a firm commitment to provide housing finance and may be valid for up to six months. We are allowing banks to meet the 10 percent speed limit on high-LVR lending measured as an average rate over a six-month period. Thereafter, the speed limit for banks with lending of more than $100 million per month will apply to the average rate over three-month periods.
Banks with mortgage lending below $100 million per month will be required to meet the speed limit on the average high-LVR lending rate over six-month rolling windows, to reflect the greater volatility seen in their high-LVR mortgage lending.
We expect that banks will modify their approach to issuing pre-approvals, in order to ensure that they fall within the 10 percent ‘speed limit' on an ongoing basis.
Speed limits on high-LVR lending may prompt lenders to consider developing and introducing products designed to circumvent the regulation. We are concerned to ensure that specially designed lending products are not developed with the purpose of avoiding or undermining the LVR restrictions. We are providing guidance to banks about the types of measures we would be concerned about if used to circumvent the LVR restrictions. The Reserve Bank expects bank senior management and bank boards to respect the spirit and intent of the LVR restrictions and to closely monitor the level of high LVR lending.
Proposed Conditions of Registration for all banks, which make these restrictions on high LVR lending operational, will be published at least two weeks prior to the 1 October implementation date.