Reserve Bank willing to set limits on risky lending

Graeme Wheeler said the growing pressures in the housing market are increasing the risks to New Zealand's financial stability. Photo / NZH

The Reserve Bank would impose the most controversial of its new tools - a limit on riskier mortgage lending with smaller deposits - if it judged those loans to be a "significant risk" to the country's financial stability.

The central bank has completed its public consultation on the use of macro-prudential tools, which aim to curb asset bubbles, and will hold talks with the major lenders over the next two months to establish the implementation of the new tool-kit, deputy governor Grant Spencer said in a statement accompanying the bank's six-monthly financial stability report.

The tools would let the central bank adjust the core funding ratio, impose "counter-cyclical buffers", require sectoral capital requirements, and restrict high loan-to-value mortgage lending.

"Overall, we do not envisage major changes to the framework proposed in the consultation documents," Spencer said.

Most of the focus in the submissions was on the use of limiting high loan-to-value ratios, with major concerns around the cooling effect they could have on first-home buyers, small businesses and the Canterbury rebuild.

Without hinting at whether the bank will impose stricter LVR criteria when it gets the new tools, it said "the Reserve Bank's aim would be to apply the restrictions at times when high LVR lending was judged to be posing a significant risk to the financial system stability."

Mortgage lending with an LVR of 80 per cent or more now accounts for about 20 per cent of banks' total residential loan books, and has made up about 30 per cent of new lending.

Westpac senior economist Michael Gordon said while today's announcement "wasn't entirely news" he suspected there was a low level of awareness in the market about the proposal.

"This increase in the capital requirement is not strictly part of the Reserve Bank's suite of 'macroprudential' policy tools (in that it won't be adjusted over the economic cycle), but it will work in much the same manner, and with the housing market continuing to heat up, the timing is surely no coincidence."

This type of adjustment was not a substitute for the Official Cash Rate, Gordon said.

"The main benefit comes from ensuring that lenders have a sizeable buffer to deal with losses in the event of a severe downturn."

ASB chief economist Nick Tuffley said the new measure was aimed at bolstering the resilience of the financial system to a shock, in this case by lifting capital held by the main banks.

"The change's effects on loan growth is less clear cut: at the margin it may slow loan growth in the high-LVR space through either reducing credit appetites for such loans or, if high loan rates were charged to cover the added capital cost, by reducing demand for such loans.

"The impacts are likely to be at the margin, and factors such as on-going supply shortages in Auckland and Canterbury and the low level of interest rates for the vast majority of borrowers will remain dominant factors," Tuffley said.

The central bank is also considering expanding the macro-prudential framework to include non-bank lenders who might mop up some of the low equity mortgage loans if banks are restricted from writing them.

Reserve Bank governor Graeme Wheeler today said the growing pressures in the housing market are increasing the risks to New Zealand's financial stability with already high prices continue to rise, though the report didn't characterise the risk as "significant".

That's being caused by a lack of housing supply, particularly in Auckland and Christchurch, and created problems for the central bank as it tries to balance those issues against a strong currency that's damping tradable inflation and hindering export returns.

Wheeler said the creation of the macro-prudential framework reflected "our concerns around housing sector developments."

The move follows similar actions by central banks in Canada, Israel, Norway, Sweden and Switzerland, which have all moved to quell the risks associated with potential housing bubbles. Those tools have been recently used in Canada and Sweden, and have been cited as "one of the factors behind the more recent slowdowns in household credit and house prices," the bank's report said.

The Reserve Bank expects to sign a memorandum of understanding with Finance Minister Bill English shortly.