A bit under three weeks ago the Reserve Bank announced a proposal for a further, substantial, extension of its LVR controls on banks’ mortgage lending It is formally a proposal, subject to a consultative process, but it is all done in such a mad rush that it is difficult for anyone to take the “consultation” process seriously. Late last year, the Bank announced that it would be allowing substantial consultative periods, and on this occasion they have offered no argument or evidence for why it is so urgent that such a short time is allowed for consultation and the preparation of submissions. Presumably it is just the impatience – backed by very little analysis – of the Governor – much the same impatience that means this is now the third attempt in three years to get LVR controls “right”. What was worse was the instruction to banks to simply fall into line now. We live in a country supposedly governed by the rule of law, not the whims of men. And until the proper consultative process has been completed, and the Governor has had regard to all the submissions, what he is proposing (a) is not law, and (b) cannot be counted on as ever being so. But just to write that is to explain why it is hard to take the consultative process seriously.
I have written and lodged a submission. It was a fairly rushed job, but I’m out of commission for the next couple of days and needed to get it in this evening.
This is the heart of the conclusion of my submission
In substance, the proposal if adopted will further undermine the efficiency of the financial system, while doing little or nothing to reduce any threats to financial stability (risks which, on your own stress tests are already very low). Indeed, there is a risk that such direct controls could increase, albeit modestly, the risk of serious financial system stresses because it will reduce the volume of capital held against bank mortgage books. Over time, the growing use of direct controls risks progressively undermining the willingness and ability of banks to do their credit risk assessments, and to compete with each other in doing so, rewarding going along with the Bank’s assessment of risks, while gaming the rules at the margin wherever possible.
Since the Bank offers us no reason to think that its own assessment of credit risks – in the aggregate or at a more disaggregated level – is superior to that of the market, and since our banks actually came through a much larger housing and credit boom largely unscathed, there is little basis for us to prefer the Bank’s judgement. And it has offered nothing to suggest how much its planned intervention might affect the probability or severity of any crisis.
Over-reliance on a very slender base of international evidence, and a failure to think hard about the distinctiveness of New Zealand (from, say, the Irish or US experience) or to make the attempt to gather and analyse New Zealand loss experiences should give citizens little reason to have any confidence in what the Bank is proposing, Even if investor loans were to prove slightly riskier, all else equal, than owner-occupier loans, the scale of the differentiation in the rules for the two types of lending suggests the Bank is driven at least as much by tilting the playing field against investors and in favour of first-home buyers as by its statutory responsibilities to use its powers in the interests of financial system soundness and efficiency. If so – and I hope there is nothing to that suspicion – it would have involved the Bank stepping well beyond its responsibilities (with little ability for citizens to hold it to account if it did so).
There isn’t much to like in the consultative document. The empirical evidence they now rely on is two studies undertaken by a central bank (the Irish one) which had already decided to have a regulatory distinction between investor loans and owner-occupier loans. One of those studies is claimed to examine the UK experience – in fact, it looks as the loan books in the UK of the three (failed) Irish banks, not necessarily a representative sample of UK experience. I’m open to the possibility that investor loans are slightly riskier than owner-occupier ones, but have simply not yet been presented with any compelling evidence. And the Bank has still made no effort to look at the experience in New Zealand, where the post-2008 reductions in house prices in some regions were not dissimilar to the UK experience, where unemployment rates lingered high, and where in some cities nominal house prices stayed well below previous peaks for a prolonged period. Obviously, New Zealand data reflecting New Zealand banking practice, New Zealand law, and New Zealand cultural norms would be more persuasive than the experience of the Irish banks (and even those research papers have some real problems).
The proposed controls differentiate between investor loans and owner-occupier ones to a huge extent. Implicit in these proposed new rules is the view that loans to an owner-occupier with an 80 per cent LVR are less risky – not just as risky – as loans to investors with a 60 per cent LVR. Nothing in the data they’ve presented warrants that sort of differentiation, and it looks like a bit of covert redistributive policy: regardless of the riskiness of the respective loans, make things harder for investors and help out the first home buyers (even though those young buyers might be getting in right near a peak). That simply isn’t the Bank’s job. It is charged with financial system soundness and efficiency: it pays lip service at best to the efficiency issues (and the way its controls will progressively undermine competitive credit allocation decisions) and its own stress tests say that the financial stability risks are slight. And why should regulatory policy be prohibiting a young person in, say, Wanganui getting into the rental property market with an LVR above 60 per cent. Direct controls lead to arbitrary boundaries, absurd outcomes, and/or ever-increasing regulatory complexity. That was part of the reason why we deregulated markets, and relied more extensively on indirect instruments, in the 1980s. it remains a good model – and served New Zealand well through the boom and bust of the last decade, when our banks came through largely unscathed.
A key feature missing from the consultative document is any recognition that to the extent that the controls reduce high LVR lending, they will also reduce the amount of capital banks need to hold against their mortgage books. The Bank argues that the proposals will reduce the risk of financial crisis, but they show no sign of having thought much about the implications of the reduction in required capital. If the capital requirements for high LVR loans were too low in the first place, that might be one thing. But our risk weights on housing loans are among the highest anywhere, and the Bank went through a consultative process not that long ago to increase those risk weights on high LVR lending. And as part of what the controls will do is push a pile of lending to just below the respective ceilings – there will be a lot of 59.9 per cent investor loans , even though a 59.9 per cent loan is little less risky than, say, a 60.1 per cent loan. Capital requirements are likely to fall further as a result, even if the underlying risks haven’t changed much. It would be unfortunate if measures ostensibly designed to reduce financial system risk actually modestly increased those risks, by reducing the capital buffers banks have to hold.
I don’t suppose submissions will make any difference to the Bank, but time (not much time, if they plan to have the restrictions in effect from 1 September) will tell.
Readers will recall that a couple of weeks ago the ANZ’s local head, David Hisco, called for the controls to be much more constraining than what the Bank is proposing. As I noted, there was nothing to stop ANZ restraining its lending accordingly. But I do hope the ANZ will now pro-actively release its submission to the consultation so that we can see if Hisco’s submission on regulatory policy aligned at all with the rhetoric in his newspaper article.
I have lodged an Official Information Act request for all the submissions the Bank receives. If past practice prevails they will eventually release those of entities other than banks, while claiming that the Reserve Bank Act prohibits the release of the bank submissions. I discussed this curious interpretation of section 105 of the Act the other day. It cries out for a short amendment to the Reserve Bank Act to make it clear that all submissions on new regulatory proposals of this sort are covered by the Official Information Act. That, of course, would be just a start on the sort of extensive reforms of the governance of the Reserve Bank that are needed.