The Reserve Bank is sailing on largely uncharted sails with its restrictions on low-deposit home loans. It remains to be seen how effective they will be in moderating the rate of house price inflation and how long they will stay in force. Innovations such as this also carry the risk of unintended or underestimated consequences. This has proved to be the case with the Reserve Bank's decision that its restrictions on high loan-to-value lending would apply to new housing construction. Sensibly, it has now reversed that policy after listening to concern about its effect on building activity.

The Reserve Bank will receive some warranted criticism for its about-turn. The whole point of the LVR restrictions is to reduce demand by taking some of the steam out of the housing market. At the same time, every effort should be being made to increase the supply of housing. Refusing to grant an exemption for new construction could only hinder that. According to the Master Builders Federation, as many as 3000 new homes a year would not be built. Yet this consequence seems to have slid by the Reserve Bank. Yesterday, it said, somewhat lamely, that it had been guided by feedback from the LVR consultation "which did not focus on the effect of restrictions on construction lending".

In its defence, it pointed out that high LVR construction lending was only about 1 per cent of total residential lending, although it financed about 12 per cent of residential building activity. That suggests the effect of the exemption will be minor. But it is clear the policy was delivering outcomes that were real enough and might have been anticipated. One other was that potential buyers with deposits over 20 per cent were shying away from building new homes because of the risk that they would need top-up loans during construction, which would take them below the percentage limit. Another was that banks were wary of loans for new houses because of the greater uncertainty and complexity associated with them.

The Reserve Bank's misstep was compounded by an initial disinclination to acknowledge the building industry's concerns. In late October, three weeks after the policy took effect, it said it did not believe "at this stage" that it was a major impediment to new building. The governor, Graeme Wheeler, also stated an understandable aversion to creating exemptions. "As with any regulation, as soon as you start building in more exemptions you create risks of avoidance and unintended consequences," he said. Another ramification, not mentioned by the governor but highlighted by the BNZ chief economist, Tony Alexander, was that this exemption will encourage others to believe the Reserve Bank's arm can be twisted by intensive lobbying.


Also pressing for an exemption are first-home seekers on modest incomes, many of whom have been shut out of the market.

But there is no case for the Reserve Bank to bow to them. They would be the group most affected if house prices declined dramatically because of a shock to the economy. Indeed, the LVR policy would cease to be worthwhile if they were exempt.

Granting an exemption for residential construction is altogether different. As the Reserve Bank observed, it will support new building and, therefore, help to reduce some of the pressure from excess demand in the housing market. That is consistent with reducing systemic risk in the banking sector. It is also consistent with a Reserve Bank that will respond to concerns if they have a valid basis.

Whatever the criticisms levelled at it, that is a commendable approach when unexplored territory is being traversed.