Low-deposit home loans 'risk to financial stability'
Wednesday, 25 November 2020
Loan to value ratio restrictions will be brought back next year as both the Reserve Bank and the Government trade blame over who should do more to rein in soaring house prices.
The Reserve Bank made the announcement on loan to value ratio restrictions (LVRs) in its Financial Stability Report (FSR) on Wednesday morning.
The FSR is released every six months. It measures the stability of the financial system along with the health of the insurance sector and payments system.
In its report, the bank stated housing and market activity had rebounded strongly despite a correction earlier in the year.
“A growing share of this lending is going to borrowers with low deposits, making these borrowers’ balance sheets more vulnerable to a correction.
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“If this trend were to continue, the stock of low-deposit home loans on banks’ books would gradually rise to a level that would constitute a risk to financial stability.”
To counter this, the Reserve Bank will bring back LVR restrictions in early 2021. It predicted the move would largely affect property investors rather than owner-occupiers as most loans made to the latter were still being made within the previous “LVR speed limits”.
“The Reserve Bank intends to reinstate LVR speed limits at the same level they were set at prior to their removal in April this year.
“That is, no more than 20 per cent of new lending to owner-occupiers at LVRs greater than 80 per cent, and no more than 5 per cent of new lending to investors at LVRs greater than 70 per cent, after exemptions.”
The report also observes economic stresses from Covid-19 have not shown up on bank balance sheets but the report predicts they will as government support schemes wind down and payment deferral schemes end.
Orr recently received a letter from Finance Minister Grant Robertson asking him to take rising house prices into account when setting monetary policy.
The dispute goes back further than the letter. Earlier in the month, Orr defended the Reserve Bank's monetary policy actions, saying the bank was not required to take house prices into account as part of its policy mandate.
Replying to questions from reporters at a media conference on the FSR, Orr said he was not surprised the bank was being called on to help.
“We would be absolutely remiss to have been surprised by a letter like that.
“All of these issues have been very high profile for decades in New Zealand.”
The FSR also lays out the risks a downturn in house prices would bring to the economy.
Loans to households make up 60 per cent of all bank lending in New Zealand. Almost all of this lending (97 per cent) is made up of residential home loans.
“The banking system would therefore be vulnerable to large losses if many households became unable to service their debts and the value of their residential properties were to fall significantly in a severe economic downturn.”
Commercial property sector ‘vulnerable’, agriculture holding up but uncertainty remains
The commercial property sector normally bears large losses during economic downturns but now there is added uncertainty around what office and retail demand might look like after the pandemic.
There is uncertainty too about the way global economic conditions could affect our agricultural sector.
While the agriculture sector has held up better than most other sectors of the economy during the pandemic, the Reserve Bank highlighted some dairy farms were highly indebted after having experienced two downturns in 10 years.
For commercial property there is uncertainty around what the long-term impact around what working from home and other societal changes might look like.
Loans to commercial property clients make up about 8 per cent of all loans within the banking system.
As people work from home, the change in work and shopping patterns could be permanent. Meaning the risks to banks exposed to this sector were “skewed to the downside”.
Prime office space in Auckland would be taken up but demand for “secondary office properties” could decline.
Firms might look to cut back on floorspace and move their remaining office operations into higher-quality buildings.
“Industry contacts have reported significant subleasing activity in Auckland and Wellington offices in recent months, suggesting this shift is already under way.”
Fiscal and monetary response pays off
A record economic contraction in June could have turned out worse without the combined economic and fiscal stimulus responses, the Reserve Bank said.
Eight per cent of mortgages were deferred in the immediate aftermath of the pandemic but the Reserve Bank observed only 1.5 per cent of mortgages were still being deferred.
The bank said the business sector too had been more resilient than expected to the record economic contraction.
The Reserve Bank also observed the situation could have been worse without the fiscal, monetary and health responses from both the Government and the Reserve Bank itself.
Overall, banks were well placed to weather the storm. They were restricted from paying dividends but still running reasonable profits – which meant they had enough capital to weather a significant worsening of economic conditions.
“The New Zealand financial system’s largest exposure is to households, chiefly through mortgages.
“The increase in house price inflation in recent months mitigates financial stability pressures in the near term but contributes to longer-term financial stability risks.”
RBNZ under pressure over housing
Under pressure from a public concerned at rapid house price increases, the Reserve Bank announced in November it would consult on reinstating LVRs next year.
The ratios hold back the amount of money lent out by banks by requiring them to source higher deposits from borrowers.
When LVR restrictions were imposed in 2013 it meant no more than 10 per cent of new bank loans could be made to people with deposits of less than 20 per cent.
In a letter to Orr, Robertson asked him to take house prices into account when making monetary policy decisions like setting the official cash rate.
However, critics have argued the Reserve Bank is simply using standard economic tools to prevent deflation in the wake of the pandemic.
Stopping the bank from using them would not change housing affordability and could cause other economic problems.
While reducing the amount of new cash flowing into the economy might change the sticker price on a house, they argue it would not change how affordable housing was relative to incomes and other goods.
Housing is unaffordable because there are not enough houses. And to change this, housing supply would need to be ramped up – an area which central and local governments are responsible for.