Regulatory Impact Assessment: Reinstating Loan-to-Value Ratio Restrictions - February 2021
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Regulatory Impact Assessment: Reinstating Loan-to-Value Ratio Restrictions February 2021 Ref #9518136 v1.2
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Contents
Adequacy Assessment .......................................................................................................................................... 3
Consultation ........................................................................................................................................................... 3
Quality Assurance .................................................................................................................................................. 3
Executive Summary ............................................................................................................................................... 4
Background and Objectives ................................................................................................................................... 6
History of LVR restrictions .................................................................................................................................. 7
Objectives of LVR restrictions ............................................................................................................................ 8
Problem Definition ................................................................................................................................................. 9
Overview ............................................................................................................................................................ 9
Housing market trends ..................................................................................................................................... 10
Sales and lending activity ............................................................................................................................. 10
House prices ................................................................................................................................................. 10
New lending to property investors .................................................................................................................... 12
Relative riskiness of investors vs other borrowers........................................................................................ 14
Lending to owner-occupiers ............................................................................................................................. 15
Current stocks of high-LVR lending ................................................................................................................. 16
Summary .......................................................................................................................................................... 17
Options considered for addressing financial stability risks .................................................................................. 17
Assessment of options ......................................................................................................................................... 20
Decision making framework for macroprudential policy ................................................................................... 20
Costs and benefits of options ........................................................................................................................... 20
Impacts on financial stability ............................................................................................................................ 22
Wider economic impacts .................................................................................................................................. 24
Efficiency costs ................................................................................................................................................ 24
Possibility of disintermediation ......................................................................................................................... 25
Effect of LVR restrictions on housing affordability ............................................................................................ 25
Effect of LVR Restrictions on distribution of housing to different groups ......................................................... 25
Implementation .................................................................................................................................................... 26
Timing of the reinstatement of LVR restrictions ............................................................................................... 27
Exemptions ...................................................................................................................................................... 27
Monitoring, evaluation and review ....................................................................................................................... 27
References .......................................................................................................................................................... 29
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Adequacy Assessment
This Regulatory Impact Assessment (RIA) provides the Reserve Bank’s analysis of reinstating Loan-to-Value
Ratio (LVR) restrictions from 1 March 2021.
The RIA has been prepared by the Reserve Bank in accordance with the requirements of section 162AB of the
Reserve Bank of New Zealand Act 1989 (the Act).
This Assessment provides a qualitative assessment of all decisions, and a quantitative assessment where this
is possible.
Consultation
A full consultation period was completed by the Reserve Bank from 8 December 2020 to 22 January 2021
following the announcement in November 2020 that we would look to reinstate LVR restrictions on 1 March
2021. Banks, stakeholder groups and the general public were provided with the opportunity to respond to the
consultation document we released on 8 December 2020.
The Reserve Bank received 23 submissions to the December consultation paper, including four from banks, two
from stakeholder groups and 17 from members of the public. A summary of submissions will be published
alongside this RIA that summarises the feedback received.
The Reserve Bank consulted the Treasury during the preparation of this RIA.
Quality Assurance
The RIA was reviewed by a number of Reserve Bank staff.
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Executive Summary
1. Loan-to-Value ratios (LVRs) are a measure of how much a bank lends to a borrower, relative to the
value of the borrower’s property secured against the lending. Restrictions on high-LVR lending are
designed to support the financial system by building financial system resilience against a disorderly
correction in the housing market, and by dampening excessive credit growth.
2. The Reserve Bank is concerned about recent growth in higher risk high loan-to-value ratio (LVR)
mortgage lending and an acceleration in the housing market against an uncertain economic backdrop.
We therefore consulted in December on whether to reinstate LVR restrictions at the level they were set
at prior to 29 April 2020, when LVRs were removed as part of our response to the adverse economic
conditions resulting from COVID-19. This document sets out our Regulatory Impact Assessment (RIA)
of the proposal to reinstate LVR restrictions. The central question considered in this RIA is whether or
not reinstating LVR restrictions would support financial stability
3. Following the consultation we are reinstating LVR restrictions from 1 March 2021. However, feedback
received during the consultation, along with analysis undertaken for this RIA, indicates that the financial
stability risks now exceed the situation at the time of the December consultation. We are increasingly
concerned about the risk that a sharp correction in the housing market could pose to financial stability.
This reflects the increasing number of highly indebted borrowers, especially investors, alongside a
rapid acceleration in house price inflation. International evidence suggests that highly-leveraged
investors – particularly ‘late stage’ entrants to the property market – play an outsize role in housing
market cycles, because these investors are more likely to sell their properties or default on loans in a
housing correction.
4. Because of this, we have decided to impose more stringent LVR restrictions than we originally
consulted on. As shown in Table 1, from 1 March 2021 the restrictions will be set at the level we
consulted on in December, which was:
a maximum of 20 percent of new lending at LVRs above 80 percent for owner-occupiers; and
a maximum of five percent of new lending at LVRs above 70 percent for investors.
From 1 May 2021 the investor restrictions will tighten further to a maximum of five percent of lending at
LVRs above 60 percent. As was the case prior to April 2020, exemptions to the regulations will apply in
certain circumstances, including for new housing construction.
Table 1: LVR restrictions being put in place.
Owner Occupier Investor
1 March 2021 Speed Limit 20 5
Threshold 80 70
1 May 2021 Speed Limit 20 5
Threshold 80 60
5. Table 2 provides a summary of the cost benefit analysis undertaken for this RIA. We assessed two
sub-options (2A and 2B) for addressing financial stability concerns – the proposal we consulted on in
December, and a second option with tighter restrictions on investors applying from 1 May. These two
sub-options were assessed against a ‘status quo’ option (Option 1) in which the LVR restrictions
remained off.
45
6. Our impact assessment indicates that reinstating LVR restrictions will improve financial stability by
strengthening bank and borrower balance sheets and mitigating the amplitude of the financial cycle.
While both sub-options are positive for financial stability, imposing tighter restrictions on investors
provides additional benefits over and above the original proposal.
7. Both sub-options also enhance economic welfare over the medium-term. This is because LVR
restrictions help to build resilience against a significant correction in the housing market as well as
reduce the potential likelihood and severity of such a correction. A downturn in the housing market can
place banks and households under pressure through negative equity and rising mortgage loan losses.
This in turn can lead to a negative feedback loop between the wider economy and financial stability,
especially if unemployment increases. Our assessment is that imposing tighter restrictions on investors
will have greater benefits to medium-term economic welfare than the original proposal.
8. Both sub-options may have small short-term negative impacts on the economy, by moderating house
price inflation and thereby reducing consumption linked to housing wealth. However these impacts are
expected to be small and significantly outweighed by the positive medium-term economic impacts.
Table 2: Summary of Cost Benefit Analysis vs Status Quo
Sub-option 2A Sub-option 2B
Reinstate LVR More stringent LVR
restrictions at April restrictions on investors
2020 level
Financial stability – strengthening bank
↑ ↑↑
and borrower balance sheets
Financial stability - mitigating the
↑↑ ↑↑↑
amplitude of the financial cycle
Short-term economic impacts ↓ ↓
Medium-term economic impact ↑↑ ↑↑↑
Efficiency costs ↓ ↓↓
↑ means better than the status quo, ↓ means worse than the status quo
9. All prudential tools have an efficiency cost, which must be weighed against the benefits. Aside from the
short-term economic impacts, the main efficiency cost associated with reinstating the LVR restrictions
is reduced credit access for low deposit but creditworthy borrowers. To help mitigate this, we are
reinstating LVR restrictions with ‘speed limits’ that allow banks to make a certain percentage of their
loans to credit worthy high-LVR borrowers. In addition, imposing restrictions on investors could in
theory have a small negative impact on investment in residential property and thereby on rental
inflation, but this will be offset by some renters becoming home purchasers. Moreover, under the
exemption rules, banks will not face LVR restrictions in their lending for new build construction, thus
mitigating any negative impacts on housing supply.
10. Efficiency costs are likely to be slightly higher for Option 2B (more stringent restrictions on investors)
than for 2A. However we consider that these costs are more than outweighed by the additional benefits
to financial stability under 2B.
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11. We expect that reinstating LVR restrictions will have an impact on house prices. Based on past
Reserve Bank research1, we consider that a reasonable estimate would be a reduction in house price
inflation of between one and four percentage points, against a counterfactual where LVR restrictions
were not reinstated. Option 2B (more stringent restrictions on investors) is expected to have a greater
impact than Option 2A in moderating house price inflation. Impacts on house prices will mainly be over
the short term (one year or less). Longer-term pressures on the housing market from factors such as a
growing population and a limited supply of housing require a range of responses that are outside the
scope of macroprudential policy.
12. We will report regularly on our assessment of these effects and may adjust the LVR settings in the
future in response to market changes or new developments.
Background and Objectives
13. Prudential policy aims to promote and maintain the soundness and efficiency of the financial system.
As a subset of prudential policy, macroprudential policy focuses on systemic risks arising from the pro-
cyclicality of the financial cycle, and the self-reinforcing interaction between credit and asset prices
during boom-bust cycles. Macroprudential policy aims to reduce the risk that the financial system
amplifies a severe downturn in the real economy. An unsustainable boom in credit and asset prices can
result in a bust that creates losses for banks, businesses and households, and hampers the ability of
banks to continue lending to the economy.
14. LVRs are a measure of how much a bank lends to a borrower, relative to the value of the borrower’s
property secured against the lending. LVR restrictions support the financial system by building financial
system resilience against a disorderly correction in the housing market, and by dampening excessive
credit growth. The more the banking system as a whole lends to high-LVR borrowers, the greater the
risk that the banking system will suffer large losses in the event of a correction. If banks do suffer large
losses, they may become unwilling to continue lending to the wider economy. Experience in other
countries suggests this can have a damaging and lasting effect on the economy.
———
1
Bloor and McDonald (2013); Price (2014); Armstrong, Skilling and Yao (2018).
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Figure 1 – Feedback effects in housing market corrections
Reduced
lending
Banks
House
funding
prices go
costs go
down
up
Banks
need Households
reduce
more spending
capital
Reduced
Defaults
economic
increase
activity
Higher
unemploy
-ment
15. LVR restrictions can also moderate the scale of economic downturns by reducing household
indebtedness and enhancing borrower balance sheets. If household balance sheets are highly
leveraged, a downturn in the housing market can put banks and households under pressure through
rising mortgage loan losses, especially if unemployment increases. In a worst-case scenario, this could
lead to a ‘fire sale’ of distressed housing assets, increasing the likelihood of a negative feedback loop
between the housing market and the wider economy (Figure 1).
History of LVR restrictions
16. The Reserve Bank first introduced LVR restrictions in 2013 in response to financial stability risks
associated with a potential house price correction and high LVR mortgage lending, and we have
adjusted settings since then. Table 3 provides a summary of the LVR restrictions that have been put in
place to date, including the new restrictions that will come into force on 1 March and 1 May.
17. When the LVR restrictions were removed in April 2020, the COVID-19 outbreak, and the measures
taken to contain it, had significantly reduced economic activity in New Zealand. Further, we expected
ongoing negative economic impacts across most sectors of the economy. The removal aimed to ensure
that banks continued to provide support to borrowers against a backdrop of uncertainty, and continued
to provide access to credit for credit-worthy borrowers. Moreover, lifting the LVR restrictions removed a
risk these might discourage banks from offering mortgage deferrals to their customers.2
———
2
https://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervision/banks/macro-prudential/LVR/April-2020-LVR-Regulatory-Impact-
Assessment.pdf?revision=083f3f24-4ae1-442f-ae3f-b742f6ce0e15&la=en
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Table 3 – History of LVR settings
Owner AKL owner
All non-AKL Occupier occupier Investor AKL Investor
Speed Limit 10 10
2013 October Threshold 80 80
Speed Limit 15 10 5
2015
November Threshold 80 80 70
Speed Limit 10 5
2016 October Threshold 80 60
Speed Limit 15 5
2018 January Threshold 80 65
Speed Limit 20 5
2019 January Threshold 80 70
Speed Limit No restriction No restriction
2020 April Threshold No restriction No restriction
Speed Limit 20 5
2021 March Threshold 80 70
Speed Limit 20 5
2021 May
Threshold 80 60
Red = tightening; yellow = steady; green = easing
Objectives of LVR restrictions
18. The objective of LVR restrictions is to promote financial stability, by directly improving the resilience of
the financial system and mitigating the extremes of financial cycles. LVR restrictions do this by reducing
the risk in the banking system by limiting household leverage to lean against the risks of a severe
correction in house prices. Moreover, LVR restrictions can also mitigate the scale of economic
downturns. In doing so, they can support both financial system stability and sustainable economic
growth.
19. Neither the long-run level of house prices nor housing affordability are direct objectives of the LVR
restrictions. The pressures on the housing market from factors such as a growing population, a limited
supply of housing, and low interest rates require a range of responses that are outside the scope of
macroprudential policy. However, when a strong run-up in house prices occurs alongside growth in
high-risk mortgage lending, this can pose risks to financial stability by increasing the risk of a sharp
correction and consequent financial sector disruption. LVR restrictions can help curb this speculative
dynamic by restricting the leverage that home owners, including investors, can take on.
20. The Reserve Bank Macroprudential Policy Framework emphasises the role of LVR policy in moderating
the amplitude of the financial cycle during the upturn and mitigating the feedback effects on the
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economy during the downturn.3 The Framework includes a three-step decision making process for LVR
policy decisions:
Assess credit and asset price growth.
Assess system resilience
Assess the risk of feedback effects between the financial system and the economy (whether
banks are maintaining lending standards by reference mainly to LVRs and DTIs).
21. The Options Assessment section of this RIA uses this framework above to consider whether it is
appropriate to reinstate LVR restrictions at the current time.
Problem Definition
Overview
22. New Zealand’s economy has proved much more resilient than expected in response to COVID-19,
particularly since nationwide lockdowns were lifted. GDP rebounded strongly in the September 2020
quarter, and unemployment unexpectedly fell in the December 2020 quarter. Consumer and business
confidence has also been rising steadily.
23. While downside risks remain, the financial system has not yet faced significant stress arising from
COVID-19. The proportion of non-performing loans on banks’ books did rise somewhat over the first
half of 2020, but since then has been falling. The mortgage deferral scheme is also winding down in an
orderly way, with the number of mortgages on deferral declining significantly, and new applications
having fallen to almost zero.4
24. In part due to the success of the health and economic policy responses (including a significant easing
in interest rates), recent months have seen a rapid acceleration in the housing market. After a small dip
in April and May 2020, new mortgage lending has grown strongly and is now running well above 2019
levels. Nationwide house price inflation has risen to approximately 20% annualised, and new records
have been set for the national median price over several successive months.
25. Continued provision of credit to sound businesses and households is important to support the
economic recovery. However, we are increasingly concerned about the risk a sharp correction in the
housing market could pose for financial stability. A growing share of lending has been going to
borrowers with high LVRs, particularly investors, making these borrowers’ balance sheets more
vulnerable to a housing market correction and/or renewed economic downturn. There also appears to
be a speculative dynamic emerging in the market.
26. In the remainder of this section, we examine in more detail the trends that have evolved since the LVR
restrictions were removed in April 2020 – including housing market activity, the flows of high-LVR
mortgage lending to investors vs owner occupiers, and the stocks of high-LVR lending on banks’
mortgage books.
———
3
This represented a shift since when LVRs were introduced in 2013, where addressing the threat of asset price inflation to financial stability was
emphasised more as a policy goal. LVR restrictions are now considered to be most effective, and efficient, when there are signs of negative feedback
effects between bank lending standards, household indebtedness and consumption, and the economy.
4
The latest data on mortgage deferrals is available on our website at https://www.rbnz.govt.nz/statistics/c65-bank-customer-lending-flows.
910
Housing market trends
Sales and lending activity
27. Table 4 shows that after falling in the quarter ending June 2020, the number of house sales rebounded
strongly, with quarterly data from the Real Estate Institute of New Zealand (REINZ) showing seasonally
adjusted sales in the December 2020 quarter more than 37 percent higher than during the same period
in 2019.
Table 4: Total dwelling sales per quarter (seasonally adjusted)
Dec 2019 Mar 2020 Jun 2020 Sep 2020 Dec 2020
20,316 19,831 11,815 25,351 27,924
Source: REINZ
32. A similar picture can be observed with mortgage lending. Figure 2 shows that the monthly change in
outstanding mortgage lending (new lending commitments less repayments) did drop to negative levels
during the lockdown period, but quickly rebounded after that. Monthly mortgage loan growth is now
running well above the levels seen from 2017 to early 2020. Furthermore, total new mortgage lending
in November 2020 was $9.3bn – a 37% increase from the prior year, and 27% higher than in the peak
of the previous housing cycle in May 2016. As will be discussed further below, a significant share of this
lending has been going to borrowers with higher LVRs, particularly investors.
Figure 2 – Monthly change in total outstanding residential mortgage lending ($m)
Source: Reserve Bank Balance Sheet Survey
House prices
33. As Figure 3 shows, house price inflation in the year to December 2020 was 19 percent nationally, and
17 percent in Auckland – a trend which has accelerated rapidly since July 2020. REINZ data also
shows that national median house prices have now set records for four consecutive months (five
consecutive months in Auckland).5 This rapid growth follows a relatively subdued period of house price
inflation from 2017 to 2019.
———
5
Ibid.
1011
Figure 3 – Year on year house price inflation
35.0% 35.0%
New Zealand
30.0% Auckland 30.0%
25.0% NZ- ex-Auckland 25.0%
20.0% 20.0%
15.0% 15.0%
10.0% 10.0%
5.0% 5.0%
0.0% 0.0%
-5.0% -5.0%
-10.0% -10.0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: REINZ
34. There are a range of factors that impact house prices, including a growing population, a limited supply
of housing, and low interest rates (driven by the need to support our inflation and employment
objectives). These require a range of responses that are outside the scope of macroprudential policy.
However, when a strong run-up in house prices occurs alongside growth in high-risk mortgage lending,
it can pose risks to financial stability by increasing the risk of a sharp correction and consequent
financial sector disruption.
Figure 4 – House price-to-income ratios for New Zealand and comparator countries
8 8
NZ Aus Can Irl
7 7
Sgp UK US
6 6
5 5
4 4
3 3
2 2
1 1
0 0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: Demographia
35. The potential risks to financial stability associated with a housing market correction are reinforced by
the fact New Zealand’s house price-to-income ratios and household debt levels are high relative to both
international comparator countries and historical averages. Figure 4 shows that house price-to-income
ratios in New Zealand have been on an upward trend and are now higher than a range of comparator
countries, including Australia, Canada, the United States and the United Kingdom. Figure 5 shows
household debt-to-income ratios have also been increasing, and are much higher for households with
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mortgages than for other households. Although debt servicing ratios have been largely stable or
declining, reflecting the downward trend in interest rates, if interest rates were to rise this could put
highly indebted households under financial pressure.
Figure 5 – Household debt-to-income ratio
Source: Stats NZ, Reserve Bank Household Assets and Liabilities Survey, Reserve Bank estimates.
36. There is a risk that the current strong rate of lending growth and house price inflation continues, given
the continued economic recovery and market forecasts that interest rates will remain low for some time.
There are a range of reasons that banks and individuals may not take adequate account of the
systemic risks posed by ‘boom and bust’ cycles in mortgage debt and house price inflation. During
periods of strong house price inflation, banks face strong competitive pressures to lend increasing debt
amounts to customers. The risks associated with this higher debt can be under-estimated by both
banks and individuals during these periods, as favourable conditions make loans seem safer. Also, as
prices rise, borrowers have more equity in their homes, which they can potentially leverage to purchase
additional property – driving prices up further in a pro-cyclical fashion.
New lending to property investors
37. Although mortgage lending has increased for all customer groups, lending to investors has been
growing particularly strongly (albeit from a relatively low base). Figure 6 shows that when measured on
a purpose basis, new lending to investors more than doubled from June to November 2020, while
lending to first-home buyers (FHBs) increased by 47% and to other owner-occupiers by 68.3%.
Moreover, when measured on a collateral basis, lending to customers with investment property
collateral doubled over the same six-month period, while lending to customers without investment
property collateral grew by 55%.6
———
6
The Reserve Bank collects residential mortgage lending data classified both by purpose (FHB, other owner-occupier, investor and business) and by
collateral type (borrowers with and without investment property collateral). Under the collateral-based approach, any lending that is partly secured
over investment property is effectively counted as ‘investor lending’, even if the purpose of that lending is for owner-occupier housing or business
rather than for new investment property. The collateral-based approach is used in calculating compliance with the LVR restrictions. Further
information is available on our website: https://www.rbnz.govt.nz/statistics/c30 and https://www.rbnz.govt.nz/statistics/c31.
1213
Figure 6 – Monthly new lending commitments by purpose ($m)
Source: Reserve Bank New Residential Mortgage Lending by Borrower Type Survey
38. Much of the recent growth in lending to investors has been at higher LVRs. Since the LVR restrictions
were removed, the share of new investor lending at LVRs above 70 percent has increased to around
35 percent of total new investor lending from around 15 percent (before exemptions), as shown in
Figure 7.7 By contrast, high-LVR lending to owner-occupiers has not changed significantly, as
discussed in the next section below.
Figure 7 – Share of new mortgage lending by LVR – Investors (collateral-based definition, before exemptions)
Source: Reserve Bank LVR New Commitments Survey
———
7
The LVR restrictions for investors were previously set at 5 percent of new lending above 70 percent LVR, but there were exemptions in place such as
for new build housing. Hence the figure shows lending levels before exemptions to ensure comparability over time.
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Relative riskiness of investors vs other borrowers
39. The potential for rising investor defaults may pose significant risks to the financial system, with a
growing body of international evidence suggesting that loss rates on investor lending are higher than
owner-occupiers during severe housing downturns. For example, detailed studies of the post-GFC
experiences of Ireland (Kelly (2014)) and the UK (McCann (2014)) have found higher default rates on
loans to investors than owner-occupiers. The Central Bank of Ireland (2014) and the UK Treasury
(HMT (2015)) have drawn similar conclusions from these studies.8
40. Additionally, evidence from the UK suggests that investors with multiple loans (i.e. multiple investment
properties) were at higher risk of default (Kelly & O’Toole (2018). This finding suggests that there may
be a case for tighter macroprudential restrictions on loans for second or subsequent properties. Kelly
and O’Toole (2018) also found that default rates are sensitive to the LVR at origination, with default
rates beginning to rise at LVRs above 60% and climbing sharply from 70%. This is shown in Figure 8
below.
Figure 8 – Mortgage default rates by LVR at origination– UK investors
Source: Kelly and O’Toole (2018)
41. This evidence suggests a higher share of investor lending in the residential sector is likely to increase
the risk of ‘fire sales’ given a correction in house prices, particularly if the lending is at higher LVRs.
This is due to both defaults (as rental incomes deteriorate) and a trader-like incentive to exit the
housing market as the cycle turns. Investors, who own multiple residential properties, are more likely to
sell properties in response to declining house prices, to de-leverage and strengthen their balance sheet
positions before they face serviceability pressures.
———
8
There are caveats to applying evidence from other economies to New Zealand, including that mortgage origination standards can vary significantly
across countries and time. These problems are mitigated by focussing on the differential between default rates for investors and owner-occupiers
identified in international studies
1415
42. Compared to an owner-occupier loan, the income used to service an investment loan may also be
more correlated with the value of the underlying asset. A sharp fall in house prices will often occur
alongside a rise in vacancy rates in an area. This will make loan servicing more difficult, particularly for
investors that have little free cash flow.
43. Investor lending can also be a strong driver of speculative rises in property markets, as the US and
Irish experience indicates. For example, Coates, Lydon and McCarthy (2015) document a strong rise in
investor activity in Ireland during the period of rapid house price appreciation up to 2007. A recent
paper by Bayer, Mangum and Roberts (2021) finds evidence of ‘speculative contagion’ in US housing
markets whereby novice investors are drawn into the market in response to the activity of other
investors in their local areas during a housing boom. Importantly, these later-stage ‘influenced’
investors were found to perform poorly relative to other investors along several dimensions, including
suboptimal market timing (buying higher / selling lower) and higher default rates in housing downturns.
44. In summary, international evidence suggests that high-risk lending to investors is of particular concern
from a financial stability perspective. This reflects both an outsize role for investors in driving prices up
in the boom phase of the housing cycle, and a higher risk of default and deleverage driving a ‘fire sale’
effect during a subsequent housing downturn.
45. We acknowledge that we do not currently have evidence from New Zealand to suggest that default
rates are higher for investors than owner-occupiers. However, this needs to be seen in the context of
the housing market having had no severe downturns in recent history (since the early 1990s at least).
The absence of a severe housing market downturn in the last 30 years is not evidence that one could
not occur in future, and data on investor behaviour in prior shallow downturns may not be a good guide
to the consequences of a future severe downturn. Moreover, as discussed above, the recent growth in
lending to investors has been significantly higher than lending to other borrowers, and a higher share of
this lending is occurring at high LVRs. This suggests that highly-leveraged investors are playing a key
role in recent rapid house price inflation, which in turn increases the risks of a future sharp correction.
46. The bank capital adequacy framework reflects the riskiness of high-LVR borrowing, including investor
borrowing, for banks’ balance sheets through higher risk weights.9 While the capital framework address
the risks these borrowers pose to individual banks, it may not fully capture the broader risks from the
feedback impacts these higher-risk borrowers pose to the financial system as a whole.
Lending to owner-occupiers
47. We have also seen a small increase in higher LVR lending to owner-occupiers, as shown in figure 9.
Currently, this remains within the restrictions that were in place before April 2020. However, the volume
of lending to owner-occupiers has increased substantially, driven in part by an increase in debt values
they are prepared to borrow relative to their incomes. The share of owner-occupier lending with a debt-
to-income (DTI) ratio of greater than 5 rose to 38 percent in September from 30 percent a year ago.
———
9
Risk weight settings for standardised banks are set out in BS2A of the Banking Supervision Handbook. BS2B sets out the approach to capital
adequacy settings for Internal Ratings Based (IRB) banks. See: https://www.rbnz.govt.nz/regulation-and-supervision/banks/banking-supervision-
handbook.
1516
Figure 9 – Flow of new mortgage lending by LVR – Owner Occupiers (collateral-based definition, before exemptions)
Source: Reserve Bank LVR New Commitments Survey
48. Although high-LVR lending to owner-occupiers is not expanding currently at the same rate as high-LVR
lending to investors, owner-occupier lending remains a potential concern, particularly given the ongoing
economic uncertainty associated with COVID-19 and high household debt levels. An increase in
defaults by owner-occupier homeowners could also contribute to the feedback effects of a housing
downturn. International evidence demonstrates significant financial stability consequences from highly
leveraged owner-occupiers, as well as from investors.
Current stocks of high-LVR lending
49. Although flows of new lending at high LVRs, particularly to investors, have increased in recent months,
new lending represents only a small share of the total stock of high-LVR lending on banks’ mortgage
books. Figure 10 shows that, for the four large banks10, the share of total mortgage loans at high LVRs
is currently at historic lows.
50. The low stock of high-LVR loans broadly reflects the success of our LVR policy in constraining risky
lending since restrictions were first introduced in 2013. However, we are concerned that the recent
increased flow of new high-LVR lending will increase the stock of high LVR lending and thus increase
long term financial stability risks.11
51. Recent stress tests12 indicate New Zealand’s banks are resilient to a range of shocks, including a
significant downturn in the housing market. However, the stress tests also show that a severe downturn
that included large falls in house prices would have a significant impact on financial stability and the
wider economy, through both mortgage loan defaults and feedback effects. We also note that while low
stocks of high-LVR lending are important for bank resilience (and the balance sheets of existing
———
10
Westpac, BNZ, ANZ and ASB.
11
We have not established an optimal level of ‘through-the-cycle’ stock of high LVR loans. This issue will be considered further as part of the future
work program to establish longer term macroprudential policy settings.
12
See https://www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2020/rbb2020-83-03
1617
property owners), they do not capture the financial stability impacts of flows of new high-LVR lending in
driving up house prices and bringing new highly leveraged investors into the market, thereby increasing
the risk of a future housing correction.
Figure 10 – High-LVR mortgages as share of total mortgage lending – Large banks
Source: Reserve Bank LVR New Commitments Survey, Banks’ Disclosure Statements
Summary
52. In conclusion, we are concerned at the recent rapid rise in house price inflation combined with growth
in high-LVR lending, particularly to investors. If these trends continue, there is an increasing risk of a
sharp correction in the housing market, which could be exacerbated by a ‘fire sale’ dynamic whereby
highly leveraged borrowers default and/or sell property to raise capital, driving prices down further.
International evidence suggests that highly-leveraged investors – particularly ‘late stage’ entrants to the
property market – play an outsize role in both the ‘boom’ and ‘bust’ phases of housing market cycles.
53. These developments also need to be considered against the background of continued economic
uncertainty due to COVID-19. While New Zealand’s economy is currently performing much better than
expected, if there were another outbreak of the virus requiring further lockdowns, the situation could
deteriorate quickly – putting highly leveraged borrowers under significant financial pressure.
54. We also note that in the absence of LVR restrictions, competitive dynamics could drive banks with
more conservative lending policies to relax these in order to maintain market share, leading to a self-
reinforcing cycle of increased risk. Prior to our announcement in November that we would be consulting
on reinstating LVR restrictions, we saw divergence between banks with some banks remaining within
the previous speed limits while others significantly increased their high-LVR lending shares.
Options considered for addressing financial stability risks
55. In December, we consulted on two options to address the issues identified in the Problem Definition
section: reinstating the LVR restrictions in place prior to the April 2020 removal, and the status quo (no
LVR restrictions). Our provisional view at that time was that reinstating the prior LVR restrictions would
be sufficient to manage emerging financial stability risks.
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56. However, as discussed in the Problem Definition section, house price inflation has continued to
accelerate since the consultation paper was published, and high-LVR lending to investors has
increased further. There is also evidence of a speculative dynamic emerging in the market, with real
estate agents reporting buying decisions being driven by expectations of future price increases and a
‘fear of missing out’.13 We therefore consider that the financial stability risks now exceed the situation at
the time of the December consultation.
57. In light of the observed increase in housing market risks, as well as feedback from submitters, we
decided to consider an additional sub-option, in which LVR restrictions are reinstated at a more
stringent level than was in place before April 2020. To decide how best to calibrate the tighter option,
we reviewed our previous LVR decisions and settings, as summarised in Table 3 in the Background
section above.
58. The increases we are currently observing in house prices and mortgage lending are similar to the 2015-
2016 upswing that resulted in us imposing our tightest LVR restrictions to date. In August 2015 the
median house price increased by 17.7 percent year-on-year, and over 30 percent in Auckland. In
December 2020 the national median house price had increased 18.4 percent year-on-year, higher than
the previous August 2015 high.
59. As shown in Figure 11, in 2015-2016 investors were a large and growing share of the market,
accounting for around a third of new lending (by purpose) in the first half of 2016. Investors account for
a smaller share of new mortgage lending today. However, similar to 2015-2016 we have seen an
increase in the investor share of the market over the past 12 months, from approximately 20 percent to
24 percent. Also, around 35% of investor lending in 2015-16 was at high LVRs (above 70%), very
similar to the share of high-LVR investor lending observed today.
Figure 11 – Investor share of new lending
40.0% 40.0%
35.0% 35.0%
30.0% 30.0%
25.0% 25.0%
20.0% 20.0%
15.0% 15.0%
10.0% 10.0%
5.0% 5.0%
0.0% 0.0%
11/2014 11/2015 11/2016 11/2017 11/2018 11/2019 11/2020
Source: Reserve Bank LVR New Commitments Survey.
60. The rapid increases in house prices and growth in highly-leveraged investor activity were key factors
that led to us imposing more stringent LVR restrictions on Auckland property investors in November
2015. The investor restrictions were then tightened further and extended nationwide in October 2016.
Evidence indicates that these tighter restrictions (among other factors) were effective in slowing credit
———
13
See https://www.blog.reinz.co.nz/reports-1/tony-february-2021.
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and asset price growth over the course of 2017-18, and helped to mitigate financial stability risks by
reducing the stock of high LVR loans.
61. We have therefore decided to calibrate the new sub-option at a maximum of 5% of lending to investors
at LVRs higher than 60% (after exemptions), as was the case from October 2016 to January 2018.
Restrictions on owner-occupiers would be reinstated at the same level under both sub-options. Table 5
summarises the options considered.
Table 5 – Options considered to reinstate LVR restrictions
Option 1 – Option 2 – Reinstate LVR Restrictions
Status Quo 2A - LVR restrictions set 2B – LVR restrictions set
at previous level tighter on investors
Owner Occupier No LVR restrictions No more than 20 percent No more than 20 percent
of new lending to owner- of new lending to owner-
occupiers at LVRs occupiers at LVRs
above 80 percent (after above 80 percent (after
exemptions). exemptions).
Investor No LVR restrictions No more than 5 percent From 1 March – as for
of new lending to Option 2A.
investors at LVRs above
70 percent (after From 1 May – no more
exemptions). than 5 percent of new
lending to investors at
LVRs above 60 percent
(after exemptions).
62. Our concerns over increased financial stability risks and the need to consider more stringent
restrictions were also informed by consideration of consultation feedback. All respondents to the
consultation supported reinstating LVR restrictions in some form (aside from one submitter whose view
was unclear). The banks, along with one member of the public, noted that reinstating restrictions would
be effective against financial stability risks arising from a sharp correction in house prices, arguing that
the recent increase in high-LVR lending was driving increased financial stability risks. Moreover, around
half of respondents considered that the restrictions on investors should be set at a stricter level than
before they were removed in April 2020, and noted the growing share of investors in the housing
market since the restrictions were removed.
63. This is backed up by three of the four major banks already announcing that they would be further
tightening investor LVR restrictions before we published our decision. ANZ and ASB have announced
they will impose a 60% LVR restriction for all investor loans, and BNZ has announced they will impose
a 60% LVR restriction for new investor customers referred via mortgage brokers.
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Assessment of options
Decision making framework for macroprudential policy
64. The Objectives section described our three-step decision making framework for macroprudential policy
decisions. Table 6 provides an assessment of the current economic and financial situation against this
framework. As the Table identifies, the rapid increase in credit and asset price growth and the risk of
negative feedback effects between the financial system and the economy suggests it is appropriate to
reinstate LVR restrictions. This will help meet the objective of LVR restrictions to promote financial
stability by limiting the amplitude of financial cycles and reducing the risk that the financial system
amplifies a severe downturn in the real economy.
Table 6 - Three step decision making framework for LVRs
Step Assessment
Assess credit and asset There has been substantial credit and asset price growth since the
price growth LVR restrictions were removed in May. We have witnessed a rapid
acceleration in house prices, with new records being set for the
national median price, and credit growth continuing at a strong pace.
New Zealand’s economic recovery from COVID-19 has been strong
and consequently, credit growth and asset prices are likely to
continue to increase.
Assess system The financial system entered the current downturn with strong capital
resilience and liquidity buffers, and has not been subject to significant stress so
far. However, stress tests indicate that in a very severe housing
downturn, bank capital ratios could come under pressure14.
Assess the risk of The rapid growth in credit in the mortgage market, especially in
feedback effects higher risk, high LVR lending in an uncertain economic environment
between the financial increases, and the increase in high debt-to-income (DTI) lending
system and the increases the risks of a negative feedback effect in the event of an
economy economic or housing market downturn.
A growing number of highly indebted borrowers, especially investors,
are financially vulnerable to house price corrections or disruptions to
their ability to service the debt. Highly leveraged home owners, in
particular investors, are more prone to rapid ‘fire sales’ that
potentially amplify any downturn. This could lead to a feedback effect
between the financial system and the economy that exacerbate an
economic downturn (as shown in Figure 1).
Costs and benefits of options
65. This section of the RIA assesses the costs and benefits of the two sub-options described above (2A
and 2B), by comparison with the status quo (Option 1). The assessment is predominantly qualitative in
nature, similar to the approach taken to in the 2013 and 2020 LVR RIAs15.
———
14
See https://www.rbnz.govt.nz/financial-stability/stress-testing
15
See https://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervision/banks/macro-prudential/LVR/April-2020-LVR-Regulatory-Impact-
Assessment.pdf?revision=083f3f24-4ae1-442f-ae3f-b742f6ce0e15&la=en. A full quantification of the costs and benefits would require a detailed
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66. Table 7 summarises the range of possible costs and benefits and compares the costs and benefits of
the two sub-options. Putting in place LVR restrictions will benefit financial stability and economic
resilience by moderating the amplitude of the financial cycle during the upturn and mitigating the
feedback effects on the economy during the downturn. The tighter investor restrictions will have a
larger positive effect on financial stability and the wider economy than the restriction we consulted on.
However, it may also have a slightly larger negative impact on efficiency costs and short term
consumption. Overall, we consider that the benefits of imposing tighter restrictions on investors
outweigh the costs, when compared both with the status quo and the restrictions we consulted on.
67. Further discussion of the key impacts is provided in the sections below.
Table 7: Assessment of costs and benefits of reinstating LVR restrictions (vs status quo)
Possible Benefit Sub-option 2A Sub-option 2B Comments
Reinstate LVR More stringent
restrictions at LVR restrictions
April 2020 level on investors
Financial stability - Reinstating LVR restrictions will limit the amount of
strengthening bank and high LVR lending on banks’ balance sheets,
borrower balance sheets although this effect is largely offset by lower risk
↑ ↑↑ weights. LVR restrictions will reduce aggregate
household indebtedness relative to the status quo,
which should increase the resilience of the financial
system to a severe economic or housing downturn.
Financial stability – By reducing the amount of higher risk, high-LVR
mitigating the amplitude lending the LVR restrictions will moderate house
of the financial cycle ↑↑ ↑↑↑ price inflation and reduce the likelihood of a severe
(‘boom and bust’) housing correction driven by negative feedback
effects. Option 2B is expected to have larger
positive impacts than Option 2A.
Medium-term economic By increasing the resilience of the financial system,
performance reinstating LVR restrictions will decrease the risk
that highly leveraged households and investors
↑↑ ↑↑↑ pose to a pro-cyclical cut to consumption and the
financial system’s ability to amplify shocks if banks
experience large losses, which would lead to
damage to the real economy.
Residential construction New construction is exempt from the LVR speed-
activity limits. Therefore, by reintroducing LVR restrictions
↑ ↑ owner-occupiers and investors with lower deposits
may look at buying or building new residential
properties, potentially supporting construction
activity.
Moderating house price ↑ ↑↑ LVR restrictions may slow annual house price
inflation inflation by an estimated 1-4 percent, against a
———model that incorporated the expected economic scenarios including the COVID-19 economic recovery, as well as household, business and bank
responses to the reinstatement of LVR changes. Such an exercise would be complex and subject to wide ranges of margins of error.
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counterfactual where the LVR restrictions are not
reinstated. These impacts will be mainly over the
short term (one year or less). Option 2B (more
stringent restrictions on investors) is expected to
have a greater impact than Option 2A.
Possible Cost Sub-option 2A Sub-option 2B Comments
Reinstate LVR More stringent
restrictions at LVR restrictions
April 2020 level on investors
Short-term economic There may be a small negative effect on
performance ↓ ↓ consumption in the short term, due to a decrease
in the wealth effect as house price inflation slows.
Efficiency costs Efficiency costs of LVR restrictions include reduced
credit access for credit-worthy borrowers with low
↓ ↓↓ deposits. This is mitigated by ‘speed-limits’
allowing some high-LVR lending. Efficiency costs
are likely to be slightly higher under Option 2B.
Impacts on rental market If the reinstatement of LVR limits results in fewer
investors buying residential property, this could
reduce the availability of accommodation or
↓ ↓ increase rents. However this would be offset by
less demand for rental properties as some renters
became property owners. In addition, the
exemption regime permits high-LVR lending on
new build investment property.
Disintermediation The use of macroprudential instruments including
LVR restrictions can also create incentives for
financial institutions to avoid the policy by operating
↓ ↓ outside of the regulatory perimeter. Reserve Bank
research (Lu ,2019) has found that historically
disintermediation has been too small to
significantly erode the effectiveness of the LVR
restrictions. We will continue to monitor this.
Impacts on financial stability
68. The LVR policy impacts on financial stability through three main channels (Lu, 2019; Bloor and Lu,
2019):
Asset quality channel – LVR restrictions reduce the share of new high-LVR mortgage
commitments, and consequently reduce the stocks of high-LVR lending over time. All else
equal, this increases the resilience of the banking system.
Risk weight channel – Reducing stocks of high-LVR loans leads to a decline in mortgage risk
weights, meaning less capital needs to be held by banks. This in part offsets the asset quality
effect above.
Indirect feedback effect channel – This effect arises from the LVR policy’s mitigation of the
magnitude of a potential correction to house prices. LVR restrictions can achieve this in two
ways – firstly, by reducing the level of distressed house sales in a downturn, and secondly by
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dampening house price inflation during an upturn. The reduction in distressed house sales
arises from a drop in stressed mortgage default rates, together with a decline in the share of
investor loans. This is because investors are more likely to either sell their properties or default
on their loans in a correction.
69. Bloor and Lu (2019) find that the main benefit to financial stability arises via the indirect feedback
channel. Specifically, by reducing the expected level of distressed house sales in a downturn (including
by reducing the share of investor lending at high LVRs), and by dampening house price inflation in an
upturn, reinstating LVR restrictions will reduce financial stability risks.
70. We expect reinstating the LVR restrictions will reduce both flows and stocks of high-LVR lending,
relative to a counterfactual in which the restrictions are left off. For owner-occupiers, we estimate that
the proposed limits of 20/80 would have had no effect on lending to these borrowers since the
restrictions were removed, since banks generally kept within the previous limits. However, reinstating
restrictions on owner-occupiers ensures that the share of high-LVR lending to this group will remain
stable in future.
71. By contrast, Figure 12 shows that there is likely to be a larger impact on investor lending flows, which
will also flow through to stocks over time. We estimate that if the 5/70 LVR restriction had remained in
place investor lending would have been approximately 15 percent lower between 1 May and 31
December 2020, and if a 5/60 percent LVR restriction were in place during this period investor lending
would have been approximately 40 percent lower. This is likely to be an over estimate of the true
impact, since some lending would have moved to ‘compliant’ LVR buckets (e.g. via investors increasing
cash deposits and/or purchasing less expensive properties) and some lending would have been
exempt from the restrictions. However, it gives an indication of the potential impact of reinstating LVR
restrictions on investor lending flows going forward.
Figure 12: Investor lending constraint if LVR restrictions were in place
Source: Reserve Bank estimates
72. Without LVR restrictions, the financial cycle can amplify the vulnerability of the economy to negative
shocks through falling house prices, reduced consumption and greater defaults on business loans,
resulting in tighter credit conditions. Quantifying the effects of LVR policy on these transmission
channels is difficult. Our estimates suggest that since 2013:
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