Whatever option is chosen, the new rules could be in place by the start of October, although the Reserve Bank acknowledged the tight timeframe may not be feasible.
"Our analysis indicates that house prices are above their sustainable level, and the risks of a housing market correction are continuing to rise," Reserve Bank deputy governor and head of financial stability Geoff Bascand said.
At the end of April 2020, the Reserve Bank dropped LVR restrictions as part of a response to Covid-19, alongside slashing interest rates and allowing mortgage holders to defer mortgage repayments without their loans being considered a credit risk for banks when calculating their capital ratios.
When the LVRs were removed the bank said they would be lifted for at least 12 months, however as house prices began to rise sharply in the second half of 2020, it reimposed them in March 2021. In May the Reserve Bank tightened the rules further for investors.
Bascand said the Reserve Bank considered yet another tightening of lending rules on investors, but concluded this would not address the risks it currently sees in the market.
The Reserve Bank said since it reimposed the rules on investors, the volume of investor lending had fallen to below its historic average, especially for high LVR lending.
"Despite this, house prices have continued to rise and we have seen a significant increase in higher risk loans to owner-occupiers."
Bascand said risky lending was rising, with most going to first home buyers.
"Lending at LVRs greater than 80 percent has nearly tripled since 2017, with the large majority of this lending going to first-home buyers, followed by existing owner-occupiers," Bascand said.
"Although our stress testing indicates that the financial system is well-placed to weather shocks such as a downturn in the housing market, we are concerned about the potential future risks to economic and financial stability of allowing this higher risk borrowing to continue at its current rates."
Bigger deposits required?
The Reserve Bank's preferred option in the consultation document is to maintain what is considered high LVR lending as being to borrowers with a 20 per cent deposit.
However it is also seeking feedback on changing what it considers to be high LVR to a 25 per cent deposit. Under that option, banks could continue to have 20 per cent of their loan book lent to high LVR borrowers.
The consultation document found that option B may do more to reduce the intensity of the credit cycle, it would also allow banks to do more lending to very high LVR borrowers.
It would also have a greater impact on first home buyers.
Friday's document seeks feedback by September 17, with the bank potentially imposing the new rules from October 1.
