Reserve bank boss backs loan rules

The Reserve Bank expects housing supply to catch up with demand.

The Reserve Bank has rejected claims that its curbs on low-deposit mortgage lending will have the perverse effect of reducing the amount of new housing.

In a speech to the Property Council in Auckland yesterday, deputy governor Grant Spencer reiterated why the bank has imposed a limit on high loan-to-value ratio (LVR) lending, what its best guess of the impact is and the indicators it will watch to decide when to lift the restrictions.

While the bank estimates house price inflation will be 1 to 4 percentage points lower than it would otherwise be over the year ahead, Spencer said house prices would still remain high relative to incomes and rents.

"In this sense it is hard to see how these restrictions will materially reduce the existing incentives to develop new residential property. Provided the red tape, costs and delays are reduced, there will remain a strong price incentive to expand the housing stock, particularly in Auckland and Christchurch."

From 2000 to 2007 house prices more than doubled, and household debt increased from 100 to 150 per cent of disposable (after-tax) income.

"When the cycle turned in 2007, house prices fell 10 per cent - a relatively benign fall compared with some countries ... where house prices fell by 30 to 40 per cent."

But now the combination of pent-up demand, low interest rates, rising net migration and a sluggish supply response has seen house prices climb to 11 per cent above the previous peak in 2007 nationwide, and 26 per cent higher in Auckland.

Spurred by mortgage rates at their lowest since the 1960s and "aggressive" competition among banks, the stock of residential mortgage debt rose 6 per cent in the year to August - faster than the incomes out of which it has to be serviced.

Lending to borrowers with high LVRs has grown twice as fast, which pushed the share of new lending at high LVRs over 30 per cent.

When exemptions are included, the Reserve Bank's regime would restrict high LVR lending to 15 per cent of new lending.

The Reserve Bank estimates that home sales will be between 3 and 8 per cent lower than they otherwise would have been over the first year.

A BNZ/Real Estate Institute survey of real estate agents found a net 41 per cent reported fewer first-home buyers in the market.

But Spencer said households that borrow at high LVRs were the most vulnerable to a fall in house prices.

"In the event that house prices fall, these borrowers are more likely to see the value of their house fall below the amount of debt they have outstanding, particularly if they have entered the market recently. This can lead to financial hardship, mortgage defaults and, potentially, stress across the broader financial system."

Although the main purpose of the LVR regime is to protect against the kind of grief that engulfed the US, Ireland and Spain when property bubbles burst, the bank also expects it to reduce inflation pressures.

"In due course, we expect housing supply to catch up with demand, and for demand to be further moderated as interest rates return to more normal levels over the next couple of years," he said.

"As the imbalance between demand and supply is reduced, we will look to lift the LVR restrictions. The indicators we will assess in this regard include house price inflation, mortgage approvals, credit growth and house sales."