Reserve Bank’s debt to income limit proposals are flawed
Report shows Reserve Bank’s debt to income limit proposals are deeply flawed
A report by Tailrisk Economics on the Reserve Bank’s justifications for possibly imposing debt to income (DTI) limits on housing lending, shows that that they are deeply flawed.
The main problem is that the DTI is a crude tool that does not adequately assess borrowers’ debt servicing capacities, and which will perversely target many better quality loans.
“The Reserve Bank has presented no substantive evidence that higher DTI loans are ‘excessively’ risky, or that a DTI ratio of 5 is a sensible cut-off,” said Ian Harrison, Principal of Tailrisk Economics, “but there is significant evidence that DTIs do not predict loan defaults, or reduce the likelihood or severity of crises”.
Systemic Risk Board found, in a recent assessment of GFC
performance, that DTI levels did not have any “relevant
effect either on the prediction of the crisis or on the
depth of the crisis” .
The application of the DTI limit to investor loans, which are the primary focus of the policy, is particularly misconceived, because DTI limits are only intended to apply to owner occupier borrowers. The DTI measure assumes that when investors purchase new properties their living expenses increase. “This simply does not make sense”, Harrison commented.
The effect of the policy could be to impose an effective LVR limit as low as 30 percent on professional investors. No other country has imposed DTI restrictions on investor loans.
“Higher future interest rates do not pose a material systemic risk, providing the conduct of monetary policy is competent” Harrison added. “Further, the Bank’s assessment that the restrictions would have a net welfare benefit, understates the costs and relies on a number of key assumptions, in particular a 25 percent chance that there will be a crisis in the next five years, with house prices falling by 40 to 50 percent. Our assessment is that the restrictions will have a welfare cost, like most misconceived quantitative interventions.”
“There are simpler, and less distortionary, ways of targeting ‘excessive’ house price rises, which appears to be the Bank’s primary motivation for DTI restrictions,” Harrison said. “Banks could be required to apply a prescribed higher test interest rate to affordibilty assessments. This would provide the Reserve Bank with an interest rate policy tool that can be directed to imbalances in the housing market.”
Report available at: http://www.tailrisk.co.nz/documents/DebtToIncome_August2017.pdf