Reserve Bank moves to slow lending

23:36, May 07 2013
Graeme Wheeler

Borrowers with a small deposit may find it harder to get a big loan from a bank or face a higher interest rate if they want to borrow more than about 80 per cent of a home's value.

The hot housing market, with prices up about 8 per cent in the past year, has seen the Reserve Bank bring in higher capital requirements for big banks for high loan-to-value ratio loans.

The Reserve Bank says house prices are "overvalued on a number of measures" and is worried about the wider impact if house prices fell sharply.

The Reserve Bank thinks part of the recent leap in house prices reflects an increasing share of high value/ low deposit loans in the past year.

About a third of new loans are made with a deposit of less than 20 per cent of a home's value, up from about 23 per cent in 2011. About 10 per cent of loans are made to borrowers with a deposit of 10 per cent a less, although they tend to be high-earning borrowers.

The balance of high value loans tend to go mostly to first home buyers with a relatively small deposit.

The move will effectively hit high LVR loans from now, though it officially applies from the end of September and could cool high-ratio house lending.

But it will be up to the banks to decide how they deal with the demand for bigger buffers for low deposit loans, either reducing the amount or charging more for the loans.  

Westpac Bank senior economist Michael Gordon said the change in capital requirements for high LVR loans was not a substitute for moving the official cash rate. And the net impact of the Reserve Bank's announcement today was likely to be small - "probably in the order of 10 to 20 basis points", he said.

"The main benefit comes from ensuring that lenders have a sizeable buffer to deal with losses in the event of a severe (house price) downturn," Gordon said.

ASB Bank chief economist Nick Tuffley said at the margin the Reserve Bank move would slow lending growth for low deposit loans, either by reducing the appetite to offer such loans or pushing up interest rates for such loans, making them less attractive.

"The impacts are likely to be at the margin, and factors such as the ongoing (home) supply shortages in Auckland and Canterbury and the low level of interest rates for the vast majority of borrowers will remain dominant factors," Tuffley said.


Earlier today, the Reserve Bank warned of "increasing risks to financial stability" with overvalued, rapidly rising house prices and rising private sector credit, although the financial system remains sound.

Issuing the central bank's latest Financial Stability Report, governor Graeme Wheeler said: "Housing pressures are increasing the risks in the financial system."

The risks in the financial system had risen in part because of the greater willingness of big banks to lend a high proportion of a home's value, with borrowers only having to find a deposit of as little as 10 per cent.

The Reserve Bank has been undertaking a review of the capital banks' hold against housing and has now announced it will increase the "risk weights" applying to high loan-to-value ratio home loans for the four big banks.

The aim is to provide a bigger buffer because of the risks of home loans equal to 80 per cent to 90 per cent of a home's value, or more. That is likely to cool such lending with the buffers increased as the loan to value ratios rise past about 70 per cent.

The increase in risk weights will apply to all current and new high-LVR loans for the big banks from now.

That will result in an average increase in capital held by the banks for housing of about 12 per cent, the Reserve Bank said today.

The increase in capital applies to the high LVR part of the bank's loan book, not the total lending.

The central bank said it wanted to make ensure bank capital requirements "adequately reflect the risks around housing lending", which had led to the housing capital review.


The aim is to strengthen the ability of the banks to weather a housing market fall and "should also lead the banks to review the riskiness of the loans they are currently writing", Wheeler said.

The governor said house prices compared with disposable incomes were already high by international standards.

"Further price escalation will worsen the potential damage that could result from a housing downturn following an economic or financial shock," he said.

House prices were rising "rapidly" in Auckland and Canterbury, household credit growth had increased and there were signs that the rebuilding of household savings was starting to "stall" the Reserve Bank said.

Household debt levels were rising from a level that was high compared with disposable income.

"House prices already appear overvalued on a number of measures," the Financial Stability Report warns.

The Reserve Bank's concerns were shared by both the OECD and the IMF in recent reports and housing risks had been noted by three major credit rating agencies.

House prices have been rising because of pent-up demand, limited new homes being built and the lowest interest rates in 50 years. The pressures were being especially felt in Auckland and Christchurch where supply constraints were tightest.

Demand was also underpinned by easier money, in terms of lower mortgage rates and an increased willingness by banks to lend at high loan to value ratios.

Reserve Bank deputy governor Grant Spencer said that while housing risks were growing, banks were performing well financially and had strong balance sheets. Banks had used an increase in profits in the past three years to strengthen their capital levels, but despite those higher capital buffers, rising house prices were creating risks for the financial system.

Higher house prices increase the probability and potential impact on bank balance sheets of a big fall in house prices.

"The greater willingness of banks to approve high loan-to-value ratio mortgages has further increased the potential adverse impact of a fall in house prices," the report says.

However, the big banks' capital levels had comfortably met the new Basel III requirements that took effect in January.

The report also highlights that borrowing by the farm sector had risen, when debt levels were already high, especially in the dairy sector.

"Recent drought conditions could expose financial vulnerabilities among these indebted farmers," the report says.

Meanwhile, the Reserve Bank recently concluded a consultation process with the banks about so called "macro-prudential policy".

A memorandum of understanding about the new policies will be signed with the Finance Minister Bill English shortly. The new framework would allow the central bank to tighten settings for the banks if house prices and household borrowing continue to be of concern.