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Reserve Bank Considers Tighter Mortgage Lending Standards

The Reserve Bank of New Zealand – Te Pūtea Matua – will soon begin consulting on ways to tighten mortgage lending standards, Deputy Governor and General Manager for Financial Stability Geoff Bascand says.

The action follows the signing of an updated Memorandum of Understanding (MoU) on macro-prudential policy with the Minister of Finance.

“The updated MoU adds debt serviceability restrictions to the list of tools available which will enable us to be more targeted in our approach to tackling financial stability risks,” Mr Bascand says.

“We are focussed on ensuring borrowers are resilient to a range of future economic and financial conditions. We are particularly concerned about those who have borrowed in the past 12 months at high LVRs and high DTIs.

“If house prices were to fall, some buyers could face the possibility of negative equity – which means the value of their property is below the outstanding balance on their mortgage,” Mr Bascand says.

“We’ve already made adjustments to Loan-to-Value Ratio (LVR) restrictions to partially manage this risk, but we haven’t seen a sufficient reduction in risky lending.”

In order to prevent this problem from getting worse, we will be consulting on a proposal to further reduce the amount of high LVR lending to owner-occupiers. We propose to restrict the amount of lending banks can do above an LVR of 80 percent to 10 percent of all new loans, down from 20 percent at present. We will begin consulting on this change later this month with a view to introducing it from 1 October 2021.

“We also intend to consult in October on implementing Debt-to-Income (DTI) restrictions and/or interest rate floors in an effort to provide further comfort that borrowing is sustainable. Introducing DTIs will take longer, whereas the banking industry has informed us that interest rate floors could be implemented more quickly.

“Consultation will be focused on operational feasibility and possible calibration of these tools, including their impacts on investors and first home buyers,” Mr Bascand says.

More information:

Background information:

What is negative equity?

This is when the value of a property falls below the outstanding balance on the mortgage.

What are loan to value ratios?

A loan-to-value ratio (LVR) is a measure of how much a bank lends against mortgaged property, compared to the value of that property. Borrowers with LVRs of more than 80 percent (less than 20 percent deposit) are often stretching their financial resources.

What is a debt to income ratio or DTI?

The DTI ratio is calculated by dividing the total debt of a borrower by their gross income. The DTI ratio is a useful measure of mortgage serviceability for owner-occupiers.

What is an interest rate floor?

Interest rate floors set a floor on the test interest rates that banks use in their serviceability assessments. An interest rate floor applies evenly across all borrower types.

Navigating for long-term economic wellbeing

Governor, Adrian Orr

House prices are above their sustainable level and the Reserve Bank of New Zealand – Te Pūtea Matua – is now considering tighter lending standards to reduce the risks associated with excessive mortgage borrowing.

It’s our role - as guardian or kaitiaki of the financial system – to limit these risks for the long-term wellbeing of everyone - borrowers, lenders, and the general economy.

One option is to require borrowers to front with a larger share of the purchase price (deposit) to reduce their exposure to mortgage debt. These tools are known as loan-to-value (LVR) restrictions.

Another option – which can be used simultaneously – is to impose rules on banks to ensure they do not lend unless the borrower is able to weather a wide range of possible mortgage interest rates and income shocks. These tools are known as debt-to-income ratios and interest rate floors. These are the tools that we can now operationalise following the signing of a Memorandum of Understanding with the Government.

We have spoken and written a lot about the many drivers of the current high house prices in New Zealand. We acknowledge that one of these reasons are the low interest rates due to our response to the COVID-19 economic shock.

We had to significantly lower the Official Cash Rate (OCR) to best meet our monetary policy mandate of maintaining low and stable inflation, and contributing to maximum sustainable employment.

The pandemic-induced global economic shock created risks of falling prices (deflation), rising unemployment, and unprecedented global financial stress. The worst of these outcomes has been headed-off by successful health management, government-led wage and business funding support, and lower interest rates aimed to boost cash-flows and keep business afloat.

This is why the current level of interest rates are historically low now. This is also why the current level of interest rates is not indicative of where they will be on average through time – or at least over the life of a mortgage.

Economic spending has recovered to above pre-COVID levels, albeit varying significantly across sectors of the economy. And, while there remains an enormous COVID-19 challenge globally, the economic consequences of the virus are somewhat clearer, and health management is advanced.

The Reserve Bank’s Monetary Policy Committee needs to think about when and how we would return interest rates to more normal levels, which are neither unnecessarily giving the economy a push forward nor holding it back. Our next opportunity to publicly address this issue is the 18 August Monetary Policy Statement.

Our monetary policy tools (especially the OCR) and our financial stability tools need to be mutually supportive. We need to continuously position the OCR to meet our monetary policy goals, and use our financial stability tools to best ensure that borrowers and lenders are financially capable and savvy enough to manage through the interest rate cycles. This is how the Reserve Bank best contributes to the economic wellbeing of all New Zealanders.

We expect banks operating in New Zealand to take heed of our signal to consult on the tightening of lending standards – both LVRs and debt servicing criteria. They must make their lending decisions with the best long-term interests of the borrower in mind. At Te Pūtea Matua, we are also making the decisions with the long-term interests of New Zealand’s economic wellbeing in mind.

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