ABC PM tonight–major policy shift by New Zealand RB?

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Stephen Long from ABC News brought to my atten­tion the fact that the Reserve Bank of New Zealand appears to be con­tem­plat­ing a return to reg­u­lat­ing lend­ing.

This is only hint­ed at at present, but it rep­re­sents a major shift in Cen­tral Bank thinking–and a wel­come one, from a debt-defla­tion­ary point of view.

I’m inter­viewed about it on PM tonight; in the mean­time, here are some rel­e­vant excerpts from the Reserve Bank of New Zealand: Finan­cial Sta­bil­i­ty Report, May 2:

New Zealand banks have been high­ly com­pet­i­tive: inter­est rate mar­gins have been low, and high loan-to-val­ue lend­ing has become more preva­lent. But while com­pe­ti­tion is to be encour­aged, its con­se­quence has been ever increas­ing lev­els of house­hold debt and upward pres­sure on house prices. Mar­gins on some lend­ing have con­tract­ed to the point where they might not be expect­ed to cov­er oper­at­ing and cap­i­tal costs on a sus­tain­able basis. This approach, if con­tin­ued, could per­pet­u­ate the hous­ing boom and increase the risk of an even­tu­al sharp down­ward cor­rec­tion. This would in turn dam­age the banks’ own bal­ance sheets.” (p. 3)

This rais­es the ques­tion of whether the exist­ing reg­u­la­to­ry frame­work for cap­i­tal ade­qua­cy is suf­fi­cient­ly sen­si­tive to the risk­i­ness of bank assets. An increased focus on risk sen­si­tiv­i­ty under Basel II will intro­duce a bet­ter align­ment of risk and reg­u­la­to­ry cap­i­tal going for­ward. For instance, high­er LVR loans will require high­er reg­u­la­to­ry cap­i­tal hold­ings. The Reserve Bank is con­sid­er­ing whether the cur­rent frame­work should be mod­i­fied in this direc­tion ahead of the intro­duc­tion of Basel II. The best con­tri­bu­tion to future finan­cial sta­bil­i­ty would be a mod­er­a­tion and grad­ual adjust­ment in the New Zealand hous­ing mar­ket. Banks should be mind­ful of this and take care that their own behav­iour does not exac­er­bate the risks inher­ent in already-stretched house­hold bal­ance sheets.” (p. 4; empha­sis added)

The report is signed by the Gov­er­nor the Bank, Alan Bol­lard.

Con­tin­u­ing with the body of the report:

Part of the recent advance in mort­gage lend­ing has involved some banks increas­ing­ly offer­ing new mort­gages that require lit­tle or no ini­tial bor­row­er deposit. This is com­mon­ly referred to as high loan-to-val­ue ratio (LVR) lend­ing (fig­ure 4.3). These prod­ucts expose banks to sig­nif­i­cant­ly more risk of loss com­pared to lend­ing that requires high­er bor­row­er equi­ty – even tak­ing into account mea­sures to mit­i­gate risk, such as mort­gage insur­ance which is used by some banks. Not only are such bor­row­ers mate­ri­al­ly more like­ly to default, but the loss in the event of default for a high LVR loan (80 per­cent or more) is much high­er than for a loan with a more con­ser­v­a­tive LVR ratio. Com­pe­ti­tion among banks has also man­i­fest­ed itself in pres­sure on inter­est mar­gins (the ratio of net inter­est income to inter­est-earn­ing assets)…” (p. 26)

While com­pe­ti­tion is to be encour­aged, from a pru­den­tial per­spec­tive we have two con­cerns. First, that returns ade­quate­ly reflect risk, as banks con­cen­trate on grow­ing lend­ing port­fo­lios by dis­count­ing lend­ing rates, at the same time as risk pro­files are increas­ing. Sec­ond, that mar­gins are sus­tain­able, in the sense of cov­er­ing fixed, vari­able and cap­i­tal costs over the medi­um term. If the nar­row­ing of mar­gins proves to be unsus­tain­able, then these mar­gins will be forced up in the future, poten­tial­ly when hous­ing has entered a down­swing. Unsus­tain­able mar­gins would exac­er­bate the hous­ing cycle and the ulti­mate impact of that cycle on banks’ own bal­ance sheets.” (p. 26)

Bra­vo! It’s still a long way from action, but acknowl­edge­ment that there is a prob­lem is a major step. This is cer­tain­ly a more mea­sured reac­tion to the lev­el of lend­ing than the Pan­gloss­ian view our own Reserve Bank recent­ly gave to a Par­lia­men­tary com­mit­tee. Let’s hope that move­ment across the Tas­man encour­ages some more real­ism over here.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.