RBNZ coy on DTIs but plans public consultation

Possible debt-to-income (DTI) ratios could be introduced by the RBNZ mid next year.

The RBNZ intends carrying out public consultation on potential DTI settings in the first quarter.

DTI restrictions on residential mortgage lending set limits on the amount of debt borrowers can take on relative to their income. This supports financial stability by limiting higher-risk mortgage lending, thus reducing the likelihood of a future housing-related financial crisis, the central bank says.

First given the green light by former Labour finance minister Grant Robertson in 2021, RBNZ has continued developing a DTI framework to complement the existing LVR policy on a different dimension of risk.

This year banks have been developing reporting and management systems so DTI restrictions can be implemented by April.

However, RBNZ assistant governor Christian Hawkesby says no decision has been made on whether a DTI ratio rule will be put in place, despite preparatory work. 

Stakeholders are said to be generally supportive of the design of the framework and agree with the RBNZ’s approach to keep it simple and clear, including treatment of personal debt in DTI calculations, business income and complex lending situations.

The DTI framework is meant to complement LVR policy and in the RBNZ’s latest financial stability report the five big banks say there has been demand from borrowers for lending at the revised LVR thresholds, although the impact of the policy easing on overall mortgage lending volumes had been marginal.

But the RBNZ is warning mortgage and loan defaults are expected to continue to rise for households and businesses in the existing economic climate.

The financial stability report says indicators suggest financial stress will continue to build. Consumer and business confidence stays weak, reflecting increased debt servicing burdens and the weaker outlook for the economy.

Consumption is expected to decline as household budgets continue to tighten. Future signs such as measures of confidence and negative news sentiment, suggest continued weakening in loan performance in the short-to-medium term.

Business lending

Meanwhile business lending is generally healthy, although significant pockets of stress are expected.

Business lending generally reprices faster than households and most of the anticipated rise in businesses’ debt servicing costs has already happened.

Business margins are low but loan defaults remain low across all industries. General deleveraging over recent years, conservative lending standards by banks and robust economic conditions have put businesses in a strong position to adapt to higher debt servicing.

The RBNZ expects financial hardship among businesses to rise as economic conditions soften. In particular, the commercial property and agricultural sectors are starting to experience challenges.

Debt in these sectors tends to be secured against property which, while initially enabling firms to borrow more relative to their income, makes them more vulnerable to higher interest rates and deteriorating market conditions.

Commercial property vulnerable

In the commercial property sector, high interest rates and other market developments have put significant downward pressure on capital values.

This is particularly the case for lower-quality office properties due to trends such as working from home.

Vacancies for lower-grade office properties are beginning to rise, putting downward pressure on rents. With the large increase in debt servicing cost over the past two years, interest coverage ratios have also fallen.

These factors mean closer monitoring of lending by banks. Serviceability stress could increase if the economy contracts and vacancies rise. Weaker demand and high construction costs mean there are few viable commercial property development projects.

Several factors support debt serviceability of commercial property operators. Commercial property loans generally have lower LVRs than residential property (usually less than 50%) and lenders require a buffer of net earnings above interest payments. Also, banks have reported that some stressed commercial property operators have other income sources to continue to meet debt servicing requirements.

Nevertheless, some property owners may need to sell portions of their portfolios to reduce debt levels if market conditions allow. Banks have increased provisions to prepare for future losses, which will help to buffer the impact on the financial system of a severe downturn.

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