Safe and sound?

Last week the Reserve Bank released its semi-annual Financial Stability Report, and concluded that while New Zealand’s financial sector is sound, it continues to face risks. Ongoing vulnerabilities in the dairy sector and housing market remain front of mind for the Reserve Bank, even with the recovery in global dairy prices and the slower pace of house price growth. But while there has been much discussion about debt-to-income lending restrictions, in our view the case for new lending restrictions has diminished.

Rapidly rising house prices, and the associated rise in household debt and risks for financial stability, have long been a concern for the Reserve Bank. In response, the Reserve Bank has tightened lending restrictions over the past few years, most recently in July when lending to property investors was effectively capped at 60% of the value of the house. While the Reserve Bank acknowledges that these restrictions have reduced the share of risky, high- LVR loans on banks’ balance sheets (thereby improving banks’ resilience to house price falls), vulnerabilities in the housing market have continued to increase. Households’ debt burden has continued to rise, with debt-to-disposable income reaching a record high of 165%. While the Auckland market remains the most stretched, pressures have been spreading to other parts of the country.

The Reserve Bank’s latest concern centres on the rising share of lending at high multiples of borrowers' income – a consequence of house prices gains far outstripping income growth. This is because high debt-to-income loans are at higher risk of default in the event of a downturn or a rapid rise in interest rates, which in turn could exacerbate the downturn through forced house sales. While the Reserve Bank’s interest in Debt to Income (DTI) restrictions is not new, it still needs approval from the Minister of Finance to add DTI restrictions to the macro-prudential toolkit. But there are still questions about how the limit would be calibrated, and who it would apply to. Other countries who have used these restrictions, including Ireland and the UK, have applied these restrictions on owner-occupiers, although any such measure here is more likely to be targeted at investors, who borrow at much higher DTIs on average.

Even if the Reserve Bank gets its wish to have DTI restrictions in its toolkit, it needs to make a case that further intervention is needed. In our view, the urgency around implementing further macro-prudential tightening has lessened in the past few months. The latest round of loan-to-value restrictions has taken the heat out of the market, with fewer houses selling, and turning over more slowly. And while prices are still rising, it’s at a much slower pace than earlier this year. At this stage, it’s hard to say whether these loan restrictions will have a sustained impact on the housing market, or if the effects prove temporary as has been the case with earlier restrictions.

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