Reserve Bank now says 'there may be value in waiting' before removing LVRs, or just easing the restrictions rather than removing them altogether
By David Hargreaves, Interest.co.nz
The Reserve Bank is conceding lessons have been learned from its disastrous decision to remove restrictions on high loan to value ratio (LVR) mortgage lending in April 2020.
But it has stopped short of calling the removal a mistake.
I said at the time the decision was announced that I thought it "was a bombshell and may be a very bad call".
Subsequently New Zealand's house prices rose more than 40% and investors particularly - who most benefited from the removal - filled their boots, with the amount they borrowed tripling in short order after removal of the LVRs.
By late 2020 the RBNZ was announcing LVRs would come back and they were duly reintroduced in 2021 as the housing market continued to roar away.
In an RBNZ article reflecting on a decade of use of macro-prudential policy, authors Chris McDonald and Shaun Markham say now; "in uncertain situations there may be value in waiting before removing restrictions".
"Alternatively, more measured adjustments could be taken such as easing LVR restrictions rather than removing them altogether."
They say in terms of the RBNZ's initial actions in removing LVRs, "we found that LVR settings were able to be loosened quickly in a little over a week but reinstating them required much longer".
"It takes time to consult publicly when tightening and banks also need time to adjust their pipeline of preapproved loans."
In another part of the same article, the authors expand further on this, saying that when an opportunity to ease LVR restrictions arises, it could be prudent to wait longer before doing so, given the requirements of tightening LVR restrictions again "if the decision turned out to be wrong in hindsight".
"Our experience during 2020 and 2021 highlights this challenge. After we removed LVR restrictions at the onset of the pandemic, high-risk mortgage lending increased and by late 2020 we had started the process of re-establishing LVR settings. However, the process took time and settings were only restored to their pre-pandemic level in March 2021."
Going back to the beginning, the authors say that in April 2020 the RBNZ was concerned that an acute tightening of financial conditions could reinforce any slowdown in the economy by further dampening investment and spending.
"It was important to break that negative feedback loop by removing potential barriers to accessing credit.
"We also did not want to impede banks from supporting their customers through the anticipated challenges.
"There was a concern that LVR restrictions could potentially impede the mortgage deferral scheme, which was implemented to make it easier for banks to support customers with temporary cashflow issues."
McDonald and Markham say that by the end of 2020, it had become clear that the New Zealand economy was stronger than expected at the time of the initial response.
"In particular, the housing market was much stronger as low mortgage rates led to accelerating house price growth," they said.
"Strong growth in house prices occurred alongside an increase in high-risk lending, which posed risks to financial stability.
"While the share of high-LVR loans on banks’ mortgage books were at historic lows, we had concerns that a large flow of new high-LVR lending would lead to a deterioration in banks’ lending portfolios if left unchecked.
"Investor activity was particularly strong given investors were more sensitive to interest rates and that they were previously more constrained by LVR restrictions.
"In addition, the low interest rate environment led to lower test rates being used by banks in their affordability assessments. New borrowers were able to borrow more relative to their income than in the past. The share of new lending with high debt-to-income ratios increased as a result.
"LVR restrictions were reinstated in early 2021 at the same level as prior to the pandemic and tightened for investors soon after.
"By mid-2021, house prices reached an unsustainably high level, increasing the probability of a sharp correction in house prices. This, along with continued flows of new high-risk lending, led to a further tightening in LVR restrictions for owner occupiers in November 2021."
The authors say that this period "highlighted the value of having a tool available to contain debt servicing risks in the macroprudential toolkit".
They say that anchoring debt levels to income could have added to borrowers’ resilience to servicing difficulties from higher interest rates, which LVR restrictions were largely unable to do because they target a different type of risk.
"DTI restrictions or a floor on the banks test rates (used in their affordability assessments) are examples of tools that could be used in this regard.
"These tools have since been added to the macroprudential toolkit. We have also recently published a framework for DTI restrictions and banks are preparing their systems so that they could be activated from April 2024."
This story was originally published on Interest.co.nz and has been republished here with permission.