DTIs still in the melting pot

Finance Minister Nicola Willis is waiting on RBNZ advice before deciding whether debt-to-income (DTI) restrictions should be implemented.

The RBNZ says DTIs will be complementary to its loan-to-value ratio (LVR) tool which has restricted lending to home buyers with a 20% deposit and investors with 40%. The major banks have some leeway in lending on lower deposits, but have kept them to a minimum.
Implementing DTIs does not require government approval, but in the past the RBNZ has sought approval from the Finance Minister before implementing new tools. Willis says the central bank is yet to speak to her about plans for the possible DTI restrictions. Until then, she is not commenting. However, National has favoured DTIs.

In a recent RBNZ article, it claims if the previous government had authorised it to introduce DTIs pre-Covid, fewer borrowers would be struggling now that interest rates are higher. 

If DTIs are applied, banks will be prepared as the RBNZ has already told them to be ready from April 2024.

In a New Zealand case study for the Bank of International Settlements, the Reserve Bank says DTIs are the most effective in supporting financial stability and sustainable house prices, while having a smaller impact on first-time buyers than on investors.

As DTI restrictions link credit availability to income, they are seen to be more effective in constraining debt levels compared with other macroprudential tools.

How LTVs have affected borrowers

The study on macroprudential policies to mitigate housing market risks by Chris McDonald says LTV restrictions have successfully added to household and lender resilience.

Housing-related risks are a major focus in the NZ financial system, McDonald says. 

Mortgage lending makes up 60% of banking sector assets and the vast majority of household debt, which is about 170% of household income in aggregate. Household debt is relatively high compared with other developed economies.

This debt is concentrated in just 39% of households that have a mortgage. The majority of households own their own home – about 60% – with the remaining largely owned by small-scale investors.

Highly indebted mortgage borrowers are particularly vulnerable to house price and economic cycles.

Prior to LTV restrictions in 2013, higher-risk lending had been building on banks’ balance sheets. At that time, about 20% of banks’ mortgage lending had an LTV ratio at origination above 80%, which was rising. This meant the banking sector became increasingly vulnerable to housing risks, including house price fluctuations.

The median house price is about nine times the median household disposable income, having increased over the past 20 years as long-term interest rates have trended lower globally. Strong population growth because of net immigration has also contributed to growing housing demand. 

Loosened then tightened

LTV restrictions have been loosened and tightened during the country’s property cycles.

McDonald says based on the RBNZ’s experience with adjusting LTV restrictions during the entire cycle, the bank has found that tightening LTV restrictions has only a limited and temporary impact on house price inflation. As such, during upswings they have not been able to materially reduce house prices towards more sustainable levels.

“The period after 2021 demonstrates that LTV restrictions have helped boost the resilience of borrowers. A rapid increase in interest rates from late 2021 contributed to house prices falling by more than 15%.

“Despite this decline, signs of distress have been limited, with few forced sales and the share of non-performing loans remaining low, at least until mid-2023. While LTV restrictions may have helped during this period, the strength of the labour market probably played a part as well.”

McDonald says the RBNZ has found that tightening LTV policy takes longer and requires more internal resources than easing because banks need time to adjust their flow of pre-approvals and carry out public consultation when tightening.

While LTV restrictions promote financial stability, they can have unintended consequences that need to be considered and managed, McDonald says. Examples of these consequences over time are:

  • Allocative efficiency of the financial system: LTV restrictions can restrict lending to creditworthy borrowers who are able to service loans but do not have sufficient equity.
  • Housing supply: When LTV restrictions were implemented in 2013, lending for construction was not exempt. Banks and industry groups raised concerns about the impact of LTV restrictions on housing supply and it  was noted at the time that while high-LTV construction lending only made up around 1% of total residential lending, it was financing around 12% of residential building activity.
  • Competition between banks: LTV restrictions may impact banks’ ability to compete with respect to certain dimensions of risk. The policy could effectively coordinate banks’ pricing, leading to tacit (and legal) collusion.
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