Amid all the noisy talk of constraints on LVRs, DTIs and interest-only loans, the Reserve Bank has quietly floated the possibility of wielding a fourth tool: treating home loans as higher risk and so increasing the capital requirements for banks to lend against residential property.
The Reserve Bank is on the verge of implementing new rules requiring banks to hold more capital to make the banking system safer, after drawn-out consultation and Covid delays. The four large banks must increase their total capital ratios from 10.5 percent to 18 percent, smaller banks must increase their capital to 16 percent.
It's an expensive obligation for the banks that has prompted grumbling from their Australian parent companies – but even before the new requirements come into force in July, the Reserve Bank has now disclosed it may go still further.
Finance Minister Grant Robertson had asked the Reserve Bank to consider the tools it can use to support more sustainable house process. So, in its financial stability report this month, it discusses the existing tool of loan-to-value ratios; it discusses the Bank's desired tool of debt-to-income ratios with a question mark over whether they can just target investors as Robertson wishes, or whether they would also restrain first homebuyers from over-extending themselves. It considers (and cast doubts on) the efficacy of restrictions on interest-only lending.
But it also discusses a fourth financial policy instrument that will have banks and borrowers alike shifting nervously in their seats. It's a proposal to get out an old tool that's been rusting in the back of the kit: changes to capital requirements on a sector-by-sector basis.
"There has been substantive change in both regulatory and fiscal policy around housing recently. Initial signs are that this is having an impact so should be given time to bed down." – Stefan Herrick, ANZ NZ
So, as well as the blanket increase to capital requirements coming into force next month, banks would also be required to increase their capital ratios still further when lending on residential property. The Reserve Bank presents this as a response to the higher risk if there is a downturn and property prices drop, leaving both homebuyers and banks exposed. But critics are dubious.
Professor David Tripe, who specialises in banking at Massey University, said New Zealand banks' capital holdings were already higher than was reasonably necessary for the risk in the housing market.
"Some people think this residential mortgage lending they're doing is unsustainably rising and there could be huge losses if there is a decline in house prices," he said. "I just don't think that decline is plausible, when we still have such a shortage of housing.
"You can certainly increase the capital holdings to penalise banks and discourage housing lending further. But what that means is that those in a less advantaged financial position will find it even more of a challenge to buy into the housing market."
The Reserve Bank acknowledges the downsides of introducing increasing capital requirements for residential housing, which might be done by either adjusting risk-weight settings or imposing a capital overlay.
The Bank conceded capital requirements for mortgage lending in New Zealand were already "relatively high" by international standards, and increasing them further would only lower house prices slowly – but it also believed some lenders were exposed. Reserve Bank data reveals that after it removed the loan-to-value limits last year, several lenders began taking on riskier debt again – more than 80 percent loan-to-value.
ANZ, ASB and Kiwibank all increased their risky lending by 2 or 3 percentage points. The Southland Building Society was highest at 18.9 percent, but the bank explains this is due to a large percentage of First Home Loans being through its relationship with Kāinga Ora – Homes & Communities and thus being fully insured by Housing NZ Corporation. (An earlier version of this story commented wrongly on the SBS high percentage representing an attitude to risk. We apologise for the error.)
Last night, in response to questions from Newsroom, New Zealand's biggest bank sounded a note of caution. ANZ spokesperson Stefan Herrick said there had already been substantive change in both regulatory and fiscal policy around housing recently. "Initial signs are that this is having an impact, so should be given time to bed down."
He indicated the bank would prefer the effects of the previous government and Reserve Bank housing, tax and lending policy changes be measured, before embarking on further changes.
"Anecdotally we’re also hearing that while demand is still strong for houses, the rate of price increases seems to have slowed," Herrick said. "All government and Reserve Bank initiatives should be considered carefully – remembering the dangers of unintended consequences.
"Ultimately, the housing crisis will be solved by more houses being built."
BNZ said much the same: "Recent changes, such as the reinstatement of LVR restrictions, may take some time to have the intended impact, as noted by RBNZ," said a spokesperson, "and we support the current approach of giving these measures time to bed-in before considering other macro-prudential measures."
Despite the doubts, that are likely to be shared by other lenders facing the imposition of new costs, the financial stability report observes there is also a plus side of increasing capital requirements.
It's a tool that's already in bank Governor Adrian Orr's kit – he doesn't need to go cap in hand to Grant Robertson to seek permission to use it. The framework is already there, so making changes would be straightforward to implement and enforce.
And, done right, it could target the right debt and the right borrowers quite efficiently.
The Bank knows this. Cavan O'Connor-Close, the manager of financial policy, said it had introduced targeted increases to capital requirements to control risky rural lending, back in 2011. Because it costs the banks more to back its lending with capital, it then passes on the higher costs to potential borrowers – who may be deterred from taking out so much debt.
"There were certainly plenty of farmers feeling pressure from banks during that period," he said. "A lot of that was highly indebted farmers who had borrowed big during the 2000s boom and had to borrow more to get through the 2009-10 downturn, coming under pressure from banks from around 2011 to reduce their debt." – Nick Clark, Federated Farmers
Willy Leferink, who was dairy chair of Federated Farmers back then, said the higher lending costs had been tough on farmers, but were nothing to the impact of the banks' self-imposed constraints last year, as the economy slowed for Covid-19.
His colleague, analyst Nick Clark, said both farmers and the banks had been worried about increasing the cost of lending, especially at that time when farm incomes had been hard hit. But by the time the changes finally came into effect, commodity prices were recovering and that eased the pain.
For about 18 months agricultural debt contracted – but from March 2012 year-on-year growth in agricultural lending resumed.
"There were certainly plenty of farmers feeling pressure from banks during that period," he said. "A lot of that was highly indebted farmers who had borrowed big during the 2000s boom and had to borrow more to get through the 2009-10 downturn, coming under pressure from banks from around 2011 to reduce their debt."
For David Tripe, it's one more tool in the kit – or according to his preferred metaphor, one more weapon in the arsenal to combat rising housing prices. He would argue, the more weapons and the more firepower, the better, but he doesn't think this particular weapon will be especially effective.
"We're shooting a machine gun into the dark without knowing where the enemy is," he said. "We're firing some rounds in the general direction, some of which will slow the enemy. But not fatally."
