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UPDATE: RBNZ wants more time before making any changes to LVRs

Wednesday 30th May 2018

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New Zealand's credit growth has slowed and house price inflation has stabilised but the Reserve Bank wants more time before it eases loan-to-value restrictions any further. 

"Financial risk has lessened with both lending and house price growth slowing in the last 12 months – in part due to our imposition of loan-to-value (LVR) ratio restrictions," said governor Adrian Orr in his first financial stability report since taking office.

However, "this more subdued lending growth needs to be further sustained before we gain sufficient confidence to again ease the LVR restrictions," he said.

Orr told reporters in Wellington that the bank would “be looking for at least the next financial stability report” before any more relaxation and said “it is still early days for the slowdown in credit growth”.

The LVRs have been in place since 2013 and were imposed to discourage banks from extending credit to riskier borrowers. It eased them at the beginning of this year as housing market pressures showed signs of abating. Currently, only 15 percent of new loans to owner-occupiers can have deposits of less than 20 percent and only 5 percent of loans to property investors can have deposits of less than 35 percent. 

Economists supported the stance. "We think the RBNZ will need to tread carefully in easing restrictions further, particularly given that investor loans can accentuate property cycles and exacerbate financial stability risks," said ANZ Bank New Zealand senior economist Liz Kendall in a note. She said by not changing the measures today "caution is clearly evident."

ASB Bank chief economist Nick Tuffley also said "clearly the RBNZ remains concerned over the risk of another housing market upswing and is taking a cautious approach." 

He said the decision "seems prudent to us" in light of the well-publicised buoyancy of the housing market in regional areas.

According to the central bank, household indebtedness has increased since 2011, coinciding with significant growth in house prices, and debt is now at a record. Indebtedness is particularly high for new homeowners and property investors.

In 1988, the average household owed around $16,000 and had an income of some $35,000 – a debt-to-income ratio of 46 percent. By the end of 2017, this ratio had risen to 168 percent, following a ten-fold increase in average household debt to nearly $160,000, while average incomes had only slightly less than tripled to $95,000, the bank said. 

As a result, borrowers remain particularly vulnerable to rising interest rates or a change in financial circumstances. 

Overall, the central bank said the financial system remains sound but is still exposed to three key vulnerabilities: household sector indebtedness, dairy sector indebtedness, and the banking system’s exposure to international risks. 

Regarding the dairy sector, it noted that most farms are currently cash-flow positive, but remain vulnerable to any possible downturn in prices and agriculture shocks. "Reducing this bank lending concentration risk requires more prudent lending practices," it said.

At the press conference, Orr reiterated that Mycoplasma bovis is an “emerging risk to the sector” but said “in terms of the dollars per kilogram of milk solid financial impact for farms, it is not that large in the immediate sense.”

Mycoplasma bovis “is a serious impact for farming, but not necessarily a serious impact to the banking system,” Orr said.  

New Zealand banks have reduced their exposure to international risks "due to strong growth in customer deposits and by raising funding at longer terms," he said. However, "the most prominent international risk is disruption from a rapid increase in global interest rates, as central banks tighten monetary policy," he said.

While "monetary policy is not expected to tighten in New Zealand for some time" domestic interest rates could rise if higher global growth causes inflationary pressures to rise in New Zealand or if higher global risk premiums increased New Zealand banks’ funding costs. 

On the insurance industry, the Reserve Bank said the sector also remains "sound, profitable and adequately capitalised" but that "some insurers have relatively small capital buffers necessary to meet future events. We are discussing this directly with the insurers."

Geoff Bascand, RBNZ deputy governor and head of financial stability, said there is currently no policy review underway to look at lifting the minimum capital requirement for the sector, but it is an open question.

“I think there is something to look at in the future,” he said.

The central bank highlighted "challenges to efficiency in the insurance sector." According to the central bank, market share remains concentrated.

"Life insurance commissions are particularly high, which inevitably flows through into higher premiums. We believe technology developments will be a key driver of competition in the future," it said. 

The central bank included a special focus on the "culture and conduct of financial institutions in New Zealand" in the report.

Banks have been in the regulatory spotlight, particularly since a Royal Commission inquiry in Australia started highlighting less than honourable practices from some banks’ Australian parents. The Reserve Bank and the Financial Markets Authority asked banks to demonstrate clearly why their customers should believe their business practices differ from their Australian parents.

"The Reserve Bank, along with other financial regulators, is taking a close interest in how the Australian parent banks are responding to these inquiries," it said. The RBNZ and the FMA have also called on New Zealand’s licensed life insurers to ask them to demonstrate how they identify and address conduct and culture issues.

Life insurers have been asked to provide written responses by June 22 that outline the actions they have taken or plan to take to identify and address culture and conduct risk, and their plans to address issues identified by the Australian Royal Commission.


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