LVR speed limits are here

RBNZ restrictions on high loan to value ratio (LVR) mortgages came into effect on 1 October 2013. They are already biting – with ASB pulling its high LVR approvals. By definition, the new rules will reduce high LVR borrowing growth, but not necessarily total borrowing (because banks are now incentivised to lend ‘traditional’ mortgages). The international evidence on impact on house prices is mixed at best and the RBNZ’s regulatory impact assessment is pretty up front about it.

Where I disagree

The purpose of the new rules is to reduce the amount of risk accumulating in the banking sector. The RBNZ’s aim should not be to reduce credit growth or house price growth per se, rather systemic risk arising from high risk debt that may have implications for financial stability, and in turn, economic stability. But it feels like the RBNZ is really targeting house prices.

The RBNZ should keep the financial stability tools as separate from monetary policy as possible. Focussing on risk in the financial system in a consistent manner would keep monetary policy independent/free of political interference. Politicians will be running interference with this policy – as we have already seen from National, Labour and Greens. This political interference should be a good reason to ask if the RBNZ should be doing both monetary policy and financial stability.

I take issue with the amount of discretion applied by the RBNZ, as Matt noted earlier. If there is systemic risk because of high risk loans, they should be using these rules all the time, rather than trying to massage things and cute market timing. To change rules on an ad hoc basis creates unnecessary uncertainty, which is costly for people making plans.

If too much credit is a bad thing, make banks hold more capital. If too high LVR is risky for the banking system, create a limit for how much of this stuff banks can hold. But to say somehow the RBNZ knows best how much credit there should be in the economy at any one point in time, or what type of credit or for what sector – has all the hallmarks of hubris and central planning on a grand scale.

It makes me shudder. Is no one else scandalised by this?

I see Rodney Dickens is. Good on Rodney for making some important points – its a good read.

Now for some relevant, toned down opinions on what is actually going on:

The new regulations

The new regulations are:

1. 10% of new mortgages can be high LVR (80%+), from 30% now.

2. The RBNZ has also increased the correlation factors for high LVR mortgages, meaning banks will have to hold more capital.

Already biting

The restrictions are already biting on new borrowing. There are two really good articles on interest.co.nz on this by:

1. David Hargreaves on how the banks have already taken notice

2. Bernard Hickey on reduced new home purchases by high LVR buyers

Changes in bank behaviour

It is not surprising to see why the RBNZ was worried about bank behaviour. A rather large portion (41%) of the growth in the big four banks’ mortgage books ($10b over the year to June) was high LVR.

There are some changes in behaviour already.

ASB pulled its pre-approvals for high LVR mortgages, even though they have three months to comply with the RBNZ’s new rules. ASB was perhaps caught on the hop with too much reliance on high LVR lending to grow its mortgage book.

I expect banks also to be much more aggressive in hunting out ‘traditional’ mortgages, possibly with lower margins. Banks still want volume growth. So this will not necessarily reduce total credit growth, as the RBNZ wants.

Changes in borrower behaviour

There will be changes in borrower behaviour. There is the inevitable gnashing of teeth by those who have worked hard to save a 5% deposit, but some will circumvent these rules by borrowing from mummy and daddy, or lenders not covered under the regime.

Richard Meadows of Fairfax does a slightly tongue in cheek look at the alternatives.

The last word

I think the RBNZ has chosen a cute market timing approach with macro prudential tools. Market timing is notoriously difficult – remember the awfully timed OCR rate hikes in mid-2010? (At that time business lending was contracting by 8%yoy). No, I don’t have confidence in the RBNZ to time the market.

To reduce systemic risk the regulations should be about higher capital adequacy and quality of their mortgage books. Financial stability should see through the cycle and have right regulations in place to let lenders and borrowers choose how they borrow and invest – without the RBNZ changing the rules on an ad hoc basis.