While Australian regulators are busy patting themselves on the back for a job well done in the rear vision mirror, the Reserve Bank of New Zealand has at least one eye to the future today as it moves another step towards new macroprudential tools. From Interest.co.nz:
The Reserve Bank says it wants to increase the amount of capital the country’s big four banks must set aside to cover potential losses from high loan to valuation ratio (LVR) home loans. Such a move would, in theory at least, make such lending more expensive for the banks.
Housing loan requirements determine the amount of capital banks must set aside to cover potential losses from lending to the housing sector. The current rules were set in early 2008 as part of the Reserve Bank’s implementation of the international Basel II capital adequacy regime.
“The aim of the current review is to ensure that banks’ baseline capital requirements for housing loans properly reflect risk in the housing sector, particularly in relation to LVRs,” Reserve Bank Deputy Governor Grant Spencer said. “The (Reserve) Bank is proposing higher capital requirements for high LVR loans.”
“A review is timely right now given the Reserve Bank’s current proposal to introduce a macro-prudential policy regime. It makes sense to get the baseline capital requirements right before the macro-prudential framework is introduced,” Spencer said.
High LVR loans 30% of new lending
Reserve Bank Governor Graeme Wheeler recently said bank loans where the borrower has less than 20% equity represent up to 30% of new lending. Credit rating agency Fitch recently affirmed its AA- credit ratings on New Zealand’s big four banks – ANZ, ASB, BNZ and Westpac – but noted the proportion of mortgages with LVRs in excess of 80% were a potential risk to the banks’ asset quality and profitability.
And recent analysis by interest.co.nz shows the country’s big five banks, combined, grew residential mortgages where the borrower has less than 20% equity by NZ$3.3 billion, or 10%, during 2012. Across the big five, which includes Kiwibank, home loans with LVRs above 80% are up NZ$4 billion, or 12.5%, to NZ$36 billion since the Reserve Bank first mandated the banks break down their home loan books by LVRs in 2008.
One of the four so-called macro-prudential tools the Reserve Bank is looking at is adjustments to risk weights on sectoral lending. Basically this means changing the amount of regulatory capital banks must hold against loans in case they go pear shaped.
Regulatory capital minimums on residential mortgages are lower than those on other lending such as business and farm loans, personal loans and credit cards. For example, a recent ANZ disclosure statement shows a 26% risk weight on retail mortgages, a 59% one on corporate (business and farm) loans, and 73% on other retail including personal loans and credit cards.
It’s also worth noting the rules differ among the banks. The big four banks – ANZ, ASB, BNZ and Westpac – use what’s known as the internal ratings-based approach. This means they build their own models to calculate their regulatory capital requirements and must then get them approved by the Reserve Bank. All other banks run what’s known as the standardised approach where the Reserve Bank prescribes their risk weights.
For the big four, capital requirements are determined by multiplying risk-weighted assets by 8%. (See table below).
By increasing the risk weight on an asset class, such as home loans, banks’ incentive to lend to that sector could be reduced because it should cost them more to do so. And if banks’ pass their increased costs on to customers, the latter will pay higher interest on their loans. However, the Reserve Bank argues banks’ own funding costs, their assessment of the riskiness of a loan or sector, and their competitive positioning are, and always will be, the most important factors setting loan pricing.
The obvious advantage here is that New Zealand will be able to dampen mortgage demand at the margin without raising interest rates and keep its currency from running even further out of control and doing long term damage to the tradeables sectors. It’s not a perfect system:
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In terms of credit growth, let’s look at what has happened since the Reserve Bank tightened the rules on the big four banks’ farm loans in June 2011. It did this in the wake of falling dairy payouts and concern over loose rural lending by the banks. The changes mean the big four banks now have to apply risk weights of up to 90% of a farm loan instead of 50%. All other banks already had to apply risk weights of 100% to all farm loans.
And what has happened to rural lending growth since June 2011? It’s up NZ$2.6 billion to a record high of NZ$49.77 billion. The Reserve Bank warned in November’s Financial Stability Report the dairy sector appeared more vulnerable to a sharp decline in the payout than at the time of the peak in dairy prices four or five years ago.
Submissions sought by April 16
Meanwhile, Spencer said the Reserve Bank would also review other aspects of banks’ capital holdings against housing loans. Any changes stemming from the review will mean changes to the Reserve Bank’s existing regulatory requirements for banks.
Submissions on the proposals close on April 16. Such a tight timeframe is unlikely to thrill the banks. However Finance Minister Bill English has said he expects to sign a deal with Wheeler by the middle of the year on the central bank’s macro-prudential tools.
China used similar tools last year to slow its property bubble and showed that it will take progressive tightening to work. But it should still keep the interest rate and currency structure lower than it would have been. In today’s world, that’s priceless.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
