International Monetary Fund says LVR limits work in boom times, not busts

Restrictions on low-deposit home loans appear to have more effect in times of boom rather than bust, according to an International Monetary Fund working paper.

The paper released this month studies the use of macroprudential policies in 119 countries from 2000 to 2013, including loan-to-value ratio speed limits which were introduced in New Zealand in 2013.

"Borrower-based policies such as limits on LTVs and DTIs, and financial institutions-based policies, such as limits on leverage and dynamic provisioning, appear to be especially effective. And policies seem more effective when growth rates of credit are very high, but they provide less supportive impact on busts," it said.

The paper also refers to other research on macroprudential policies in Asia-Pacific countries that suggested the tools work better when they complement monetary tightening rather than act in opposite directions.

The Reserve Bank made banks limit their mortgage lending at high LVRS (above 80 percent) to no more than 10 per cent of new mortgage lending. The latest figures for January show the amount of new residential mortgage lending at high LVRs, which has higher default rates, has fallen to 5.8 per cent compared to 24.4 percent in September 2013 and comfortably within the 10 percent limit.

The Reserve Bank introduced the LVR speed limits to help reduce financial sector risks from an increased share of high loan to value mortgage lending, high levels of household debt, and an over-valued housing market. The concern was to ensure the financial sector was robust enough to withstand a substantial house price correction as happened in some countries after the global financial crisis.

A new bank paper out today says the vulnerability of owner-occupier mortgage lending undertaken during 2011 and 2013 was higher than the previous four years. That was mainly due to more high-LVR borrowers with higher debt to income levels that would be impacted by a mortgage rate rise or fall in income, it said. That reflected sharp increases in Auckland house prices and a easing in bank lending standards in recent years, the paper said. Recent buyers had a median debt of $219,400, well above the $147,000 for existing borrowers.

A May 2014 review by the Reserve Bank six months after the LVR restrictions were introduced concluded the policy had worked and that without it, house price inflation would have been 3.3 percentage points higher and household credit growth could have been just under 1 percent higher.

In the bank's six-monthly Financial Stability Report released in November, the Reserve Bank said the housing market had cooled since the introduction of the temporary LVR restrictions with annual house price inflation dropping to 5 percent in September from over 9 percent at the same time the previous year.

Even in Auckland house price inflation, which reached 17 percent in August 2013, had slowed to below 9 percent in September 2014, the report said. It did admit first-home buyers had been adversely impacted by the limits, with the proportion of first-home buyer sales running at around 17 percent in 2014, a little lower than the average.

While the bank labelled the policy a success, supply constraints and high migration in Auckland are continuing to drive up demand and its report said there remains a risk of a resurgence in housing market pressures. Ratings agency Standard - Poor's said this week the LVR restrictions are likely to continue for longer due to the surge in Auckland house prices since September.

The Reserve Bank is continuing to assess whether to bring in new capital requirements for investor mortgages, which are considered riskier than those to owner-occupiers. It's likely to drive up the cost of loans to investors because banks will have to hold more capital to cover them.

While not a macro-prudential policy, it does pave the way for the central bank to pull out one of the other tools in its toolbox if necessary in future. Some pundits are picking some sort of debt-to-income restriction, like that introduced in the UK last year, could be considered if Auckland's housing market gets too over-heated.