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Loan-to-value restrictions effective but have some drawbacks - RBNZ

Wednesday 22nd May 2019

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New Zealand's loan-to-value ratio restrictions have been effective in improving financial stability but the policy comes with drawbacks, says the Reserve Bank after a detailed review. 

“By improving the resilience of both households and banks, LVR policy has played a useful role in promoting financial stability during a period of heightened housing market risks,” deputy governor and head of financial stability Geoff Bascand said. The findings form part of a wider review of macroprudential policy.

The LVR restrictions were initially introduced in 2013 in a bid to make bank balance sheets stronger, although curbing an overheated housing market was a secondary goal. "By mitigating the scale of house price falls during a potential downturn and limiting the indebtedness of households, the policy has made the financial system more resilient to a housing-led downturn," the review said. The LVRs have been adjusted in response to changing risks. 

The Reserve Bank considered introducing capital macroprudential tools - which would have required lenders to hold more capital on their own balance sheets - but opted to use LVRs restrictions. However, it did tighten baseline capital rules for high LVR loans. 

The central bank said LVR restrictions tend to have a greater impact, directly reducing housing and household sector risks, and mitigating the scale of an economic downturn, than capital-based macroprudential tools that are focused on building additional bank capital buffers for absorbing shocks. 

It noted, however, "while the LVR policy can lean against the systemic risk posed by a house price fall, it cannot be expected to address the risks stemming from housing market exuberance all on its own." 

The LVR policy is not designed to target a particular level of house prices. Broader policy reforms would address housing supply shortages, the distortions associated with the taxation regime and high net migration, which are fuelling house price inflation and risks of a correction in the future should these drivers weaken," it said. 

The central bank has begun easing the macroprudential policy in recent years in response to a lower risk of a housing market correction and prudent lending standards.

"If the two conditions continue to be met, the Reserve Bank plans for further ease the LVR policy," it said. The policy will be eased gradually to allow time to test whether the conditions are met.  

Regarding drawbacks, it noted the LVR policy could have impacts beyond financial stability that have the potential to undermine other public policy objectives.

For example, the LVR policy is likely to prevent some households from purchasing housing, which is part of the process of safeguarding financial stability. However, this means that the LVR policy can negatively affect a public policy objective of housing affordability, including for first home buyers.

The regional LVR adjustment - which involved tightening restrictions for Auckland investors and easing them for borrowers outside of Auckland - coincided with a strong pick-up in house price inflation and house sales in the rest of New Zealand.

The announcement of the introduction of the LVR policy led some buyers to bring forward their purchases prior to implementation of the policy, and the same effect was observed in Auckland leading up to the second tightening.

In theory, putting pressure on buyers to hasten their purchase represents a distortion to market outcomes, and can undermine the effectiveness of the policy, it said. The actual impact was small, it said.  

And while the Reserve Bank reiterated that the LVR tool is not a lever for monetary policy, it said the "impact of the LVR setting on domestic demand and inflation should be considered when making decisions on monetary policy." 


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