Reserve Bank's call on loan ratios, says English

Bill English says the Reserve Bank must make independent decisions on its approach. Photo / David White

Finance Minister Bill English confirmed yesterday that any decisions about adjusting loan-to-value ratios or banks' capital and funding requirements would be made independently by the Reserve Bank.

"The temptation for some politicians to fiddle with the economy at the expense of long-term pain would be too great [otherwise]," he said in a speech in which he outlined the next steps in the process of equipping the bank with macro-prudential - or, as he preferred to call them, "financial stability" - tools.

The bank is due to issue a consultation document next month on plans for additional instruments, intended to reduce the risk of the kinds of boom/bust credit and asset price cycles which lay at the heart of the global financial crisis.

They include requiring banks to hold additional capital as a buffer during an economy-wide credit boom, of up to 2.5 per cent of risk-weighted assets.

That framework is already expected to be implemented at the start of next year.

Normally banks would be given a year's notice of such a change, to give them time to raise the extra capital.

Another, more targeted tool would be to require banks to hold additional capital against loans in specific sectors, such as dairy farm or residential mortgages, if risks emerge in those sectors. It would increase the cost to the banks of advancing such loans without raising borrowing costs across the board.

A third tool, adjusting the core funding ratio (CFR), is already in place.

In the wake of the global financial crisis the Reserve Bank has required the banks to get at least 75 per cent of their funding from retail deposits or longer-term wholesale sources, to reduce their reliance on the short-term funding markets which froze during the crisis.

Bank of New Zealand economist Craig Ebert said the CFR might serve as a self-regulating mechanism in the monetary cycle, relieving pressure on the official cash rate to do as much.

"As credit growth picks up, the CFR might well force banks to bid up deposit rates in order to best fund the extra lending."

That, in turn, could put upward pressure on retail lending rates, without any moves in the OCR or where the market projects the OCR to go.

The fourth instrument would be to restrict loan-to-value ratios, that is, the proportion of a property's value which a bank can lend on that security.

"We can understand why the Reserve Bank is a bit wary of using such a tool willy nilly. It's potentially more blunt an instrument than the OCR," Ebert said.

"It would be very difficult to implement with regional discretion, for instance. And a blanket lift in the LVR could also be problematic, for example, by being irrelevant for speculators with lots of equity, while crushing first-home buyers looking to pick up a fairly valued house or apartment."

It would represent regulatory control of private bank lending decisions and run the risk of "disintermediation" - shifting the riskiest lending towards entities not covered by the regulation.

English said he expected to sign a memorandum of understanding with Reserve Bank governor Graeme Wheeler by the middle of the year.

"There are some expectations that these tools will be used immediately to dampen the Auckland housing market," he said.

Those decisions would lie with the Reserve Bank.

But the greatest influence on the housing market will continue to be interest rates and supply constraints created by the planning system, English said.