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 banksâ€™ 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 â€“ 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 banksâ€™ 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.