Restrictions on mortgage lending will be lifted for at least 12 months, with the Reserve Bank saying concerns about risky lending were outweighed by worries that banks will be too reluctant to lend.
On Thursday evening the Reserve Bank announced that it had concluded consultations on whether to ease loan to value ratio (LVR) restrictions in response to the Covid-19 pandemic.
The central bank has also allowed banks to let customers defer mortgage repayments for up to six months without having to class the loans as non performing.
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Introduced to protect the stability of the financial system as house prices climbed, the LVR rules placed restrictions on how much of a bank's lending could go to borrowers with a deposit of less than 20 per cent of the value of the property.
The Reserve Bank said its mortgage deferral scheme could have implications for LVRs, with interest on the loans continuing to accrue.
In a statement, the Reserve Bank warned the bigger risk to stability was currently a lack of lending.
"Given the current uncertainty around the economic outlook, the Reserve Bank considers that it is unlikely that banks will weaken lending standards to high risk borrowers," Geoff Bascand, the Reserve Bank's head of financial stability, said in a statement.
"The more likely risk is that banks are overly cautious with lending to credit-worthy borrowers."
The decision comes after a short consultation period. Bascand announced the bank was proposing to lift the restrictions on April 20. The rule changes take effect on Friday.
"Although the consultation period was short by the Reserve Bank's typical standards, this was necessary to respond swiftly to an unprecedented set of economic events," Bascand said in a statement.
The bank received "more than 70" submissions from the public and industry, as well as approaching non government groups seeking feedback.
All of the New Zealand incorporated banks which responded to the consultation were in favour of removing the restrictions.
A number of submitters were against the easing. "Many were concerned about potential adverse impacts on financial stability, such as the risk of bank failure," the Reserve Bank statement said.
"They also noted that the economy has weakened and job security has reduced, and the ability of people to service a mortgage will likely decline in the coming months."
A regulatory impact statement concluded the removal of the LVRs did not weaken the resilience of the system.
"Removing LVR restrictions now supports financial stability by removing one potential obstacle to the flow of credit in the economy, helping to soften the downturn."
Bascand said the banks would monitor lending over the next 12 months as the economic impact of Covid-19 became clearer. "We will review the most appropriate setting for LVRs in a year's time".