RBNZ adds new option to DTI consultation

The Reserve Bank (RBNZ) has started consultation on debt-to-income ratios, but added a new, and more sensible option.

This could involve making banks impose tougher risk-assessment measures on would-be borrowers.

The RBNZ wants comment from the finance industry on so-called debt serviceability restrictions (DSRs).

It is the latest in a series of measures to reduce banking sector vulnerability to an over heated property market.

The RBNZ says even though banks in this country are well-capitalised, the combination of very high debt levels and unsustainable house prices poses financial stability risks.

Its main method of dealing with this is the well-publicised Loan-to-Value-Ratio (LVR). This limits banks to no more than 10% of first home sales going to people with a deposit of less than 20%.

But it is now going further and consulting with the public and the industry over the viability of DSRs.

Of these, the best known is the Debt to Income Ratio (DTI). The RBNZ has already signaled its intention to consult on this and is now formally inviting comment.

Some banks have already anticipated a move with the BNZ saying a multiple of six is the level it will use in its own DTI.

The Reserve Bank is also looking at another sort of DSR: a floor on the test interest rates used by banks in their loan serviceability assessments.

These test the ability of borrowers to continue repaying their loans if interest rates rise above the level they were at when the loan was first taken out.

If approved, this would standardise the way banks assess the dependability of a loan, which they currently can vary depending on the wealth of a loan applicant.

It could also mean borrowers would have to be prepared to demonstrate they could face a higher potential interest rate than they are assessed on at present.

At this stage the RBNZ is not planning to implement either method, but it wants to have them ready in case of trouble.

A former Reserve Bank official, now an independent economist, thinks of the two methods under consideration, a floor on serviceability assessments is by far the better of the two options.

Ian Harrison, of Tailrisk Economics (pictured), says DTI is far too simplistic, since interest rates that go up and down can complicate a simple comparison between income and debt. A floor would work far better.

“Banks have a test rate, they don't just look at your current interest rate but they look at a higher interest rate, that is your test rate, and often that is about 6%.

Harrison says banks need to know that borrowers could service a loan at a higher rate in future than is being offered at present, to ensure their money is safe.

Amending the way banks make that judgment would be far more reliable in the fight to safeguard monetary system from risky debt than a simple DTI.

This view however contrasts with the RBNZ's belief that DTI restrictions would work better.

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