Should regulators limit bank lending for highly geared mortgages?

In Auckland, the limit is 70 per cent for loans to investors in property.

In a bid to lessen the effect of asset price bubbles, New Zealand’s central bank now restricts banks from writing mortgages with a loan-to-valuation ratio higher than 80 per cent. Three experts share different perspectives on this policy.

David Tripe

Associate professor at the School of Economics & Finance, Massey University, New Zealand

David TripeSince 2008, policymakers around the world have become much more aware of how the financial system might be endangered by an asset price boom and bust. Charged with keeping New Zealand’s financial system stable, the Reserve Bank of New Zealand is trying to limit the potential costs of bank failures that might result from a housing bust.

This policy is not doing much to slow down the rise in housing prices. The latest rules, which come into effect on 1 October, will probably engender some slowdown in the rate of housing price rises, but that will not be a long-term effect. 

So the policy is not necessarily reducing the risk of a bust in the housing market. Its real benefit lies in reducing the riskiness of banks’ loan portfolios. When banks cannot lend past a certain loan-to-valuation ratio, a housing price bust will damage them less.

"There is some evidence that the policy is, as expected, reducing risk within the banking system." David Tripe

Has the riskiness of banks’ portfolios in fact reduced under the new policy? The proportion of loans that are for more than 80 per cent of property value has substantially reduced since the system has been in place. So there is some evidence that the policy is, as expected, reducing risk within the banking system.

Contrast this with Australia’s lack of regulatory clarity on this issue. The Australian Prudential Regulation Authority, which oversees Australia’s financial stability, won’t publish explicit rules. Yet when it feels the need, it leans informally on banks to cut back on investor lending. 

If the policy is worth pursuing, it is worth spelling out clearly.

Mardi Dungey

Professor of Economics & Finance at the University of Tasmania

Mardi DungeyLimiting bank exposure to mortgage products has a long history. Typically, banks are encouraged by prudential regulation around the world to diversify their portfolios to manage risk. When this conflicts with the pressures created by a bubble, then financial innovation often results.

Think, for example, of the US experience in the years to 2008: the actual problems were in the securitised mortgage markets. Banks only had excess exposure to the US housing market because they had been slow in processing originated (high-risk) housing loans through securitisation – and, in the name of client relationships, they were forced to take back some of the securitised products when those products experienced dramatic losses.

The important question here is whether economic policies and structure support the bubble. Around the world, this varies considerably. Everything from tax policy to the attractiveness of particular cities can affect it.

"Leaning against asset price bubbles is complex and situationally specific. The problems will vary from country to country." Mardi Dungey

The structures of housing markets differ: while home ownership is aspirational and high in Australia and the US, lifetime rental is the norm in European countries such as the Netherlands and Germany.

Housing funding also differs: fixed interest rate loans are preferred in New Zealand and the US, and floating-rate loans in Australia and the UK, while multi-generational mortgages are common in Japan.

All of this serves to demonstrate that leaning against asset price bubbles is extremely complex and situationally specific. The problems will vary from country to country, so blanket rules are unlikely to be helpful.

Rod Maddock

Adjunct professor of economics at the Monash Business School, Monash University

Rod MaddocCentral bankers now appear to be the heroes of our times. They will boost the economy when it is slack, push the currency up or down as they see the need and help manage banks by telling them how and who to lend to. 

These superheroes are largely unaccountable. The push for central bank independence from government in the 1990s has been completely successful – so much so that central banks now feel comfortable raising or lowering rates during election periods, when the fate of governments can hang on the decision.

These changes create obvious problems.

"There is a long debate in economics about whether anyone can identify a bubble in advance." Rod Maddock

The first problem is informational. There is a long debate in economics about whether anyone can identify a bubble in advance, and if it cannot be identified, then taking action is difficult to justify.

By preventing some lending, such as for mortgages, the bank or regulator is ultimately guessing. If the guess is right, there is some probability that a bubble might have been stopped from exploding. However, stopping lending has clear consequences as well, all to the downside.

The second problem is democratic. Faced with the asymmetry, banks are likely to stop credit growth too early and too often. The explosion of a bubble is obvious, while a period of slow growth resulting from the suppression of credit is not. Unemployment will be higher, and fewer people will have homes – but no-one will blame the central bank.

Do we want an unelected committee of experts making major gambles with our lives?

Professional development: CPA Q&A. Access a handpicked selection of resources each month and complete a short monthly assessment to earn CPD hours. Exclusively available to CPA Australia members.

The experts

David Tripe
David Tripe has taught banking at Massey University since 1994 and is an associate professor in the School of Economics & Finance. He has a PhD in Banking and is a leading researcher and commentator on New Zealand’s banking sector, giving particular attention to banks’ financial performance and regulation.

Mardi Dungey
Professor Mardi Dungey leads the University of Tasmania’s finance group, holds additional posts at Cambridge University and Australian National University, and is a fellow of the Academy of Social Sciences in Australia. She has also worked at Econtech Consulting Group and the Reserve Bank of Australia, and has held visiting positions at the International Monetary Fund, Manchester University, Princeton University, the Federal Reserve Bank of Atlanta and the Australian and New Zealand Treasuries.

Her research emphasises the interactions between financial markets and the economy and the transmission of financial shocks around the world.

Rod Maddock
Rodney Maddock is adjunct professor of economics at Monash University, a vice-chancellor’s fellow at Victoria University and president of the Economic Society of Australia’s Victorian branch. He was previously a senior executive at the Commonwealth Bank of Australia after earlier stints as chief economist for the Business Council of Australia, head of economic policy in the Victorian Cabinet Office and professor of economics and head of the business school at La Trobe University.

He is a frequent writer and conference speaker; his books include The Australian Economy in the Long Run and Unlocking the Infrastructure.

Read next: Why do house prices keep rising in countries like Australia and Singapore?

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