It has been nine months since the Reserve Bank’s most recent policy child was brought into the world and, over this period, high loan-to-value residential lending has fallen by almost 80%.  The limits for high-LVR mortgage lending were implemented to strengthen the financial system against housing market shocks and ease house price inflation.  However, the restrictions have had a far greater effect on low deposit home loan issuances than perhaps initially intended.  This article delves into why high-LVR loans, which once made up 25% of residential mortgage lending from banks, have reduced to levels far below that which the Reserve Bank policy allows. 

A short history of a young policy

Implemented in October 2013, high-LVR restrictions limit the proportion of lending banks can make to homebuyers who front up with a deposit lower than 20% of the dwelling’s value.  Of all the new home loans banks issue on average over a six month period, only 10% can be in the high-LVR category.  In December, the Reserve Bank announced that loans for those building a new home were excluded from the high-LVR restrictions.  The purpose of this exemption was to allow housing stocks to expand unrestrained and thus, to reduce upwards pressure on house price inflation (particularly in Auckland and Christchurch).  As a result, the 10% 'speed bump' on high-LVR lending now only applies those buying an already existing dwelling with deposit under 20% of the home’s value.

The resulting effect on lending has been more extreme than the policy requires

Following the implementation of LVR restrictions, the proportion of bank lending for high-LVR loans dropped to a low of 3.6% within four months (after exemptions).  This extremely low level of high-LVR lending was well within the Reserve Bank’s 10% prescribed limit and was largely attributed to banks being extremely cautious as they transitioned into the new policy environment. As banks became used to the new rules, we expected them to expand their high-LVR lending.  However, over the three months to April, high-LVR lending (excluding construction) has still only averaged 3.9% of total residential loans.  With enough 'wiggle room' to spare, banks still haven't been expanding high-LVR lending anywhere near their 10% allowance. 

A number of hypotheses could explain this result:

At first glance, many have argued that banks are simply being very wary of exceeding the 10% limit so have been deliberately cautious in their lending behaviour.  However, this argument is not very compelling, as there has been very little variation on a month to month basis in the high-LVR lending rate.  Excluding exemptions, high-LVR lending over the past six months have stayed within a tight band of between 3-6% of new residential lending – indicating that banks have enough control over their lending to increase it and still remain within the 10% limit.

But perhaps there are other reasons for banks to exercise caution. Since the Global Financial Crisis, the Reserve Bank has been looking at, and implementing, new policies to enhance financial stability (raising tier one capital ratios to 6% was one initiative, as was introducing high-LVR restrictions).  Complying with each new policy, ultimately limits bank liberties in the financial system.  Banks could be 'over complying' to LVR restrictions in a bid to minimise the risk of other more restrictive policies being implemented in the future.

Alternatively, ‘over compliance’ could be a tactic to limit the endurance of the current LVR restrictions.  The LVR restrictions are not intended to be permanent and as the Reserve Bank has said that the duration of the policy is dependent on their effectiveness – greater-than-expected compliance could shorten this period. 

However, there is a lot to lose from any kind of 'over compliance' with regulations, particularly when there is no agreement that doing so will shorten the duration of the current policy or prevent further regulations.  Despite its risks, high-LVR lending is perhaps one of the more profitable forms of residential lending – the loan sum is larger, which ensures a longer stream of interest repayments. 

Finally, there are two sides to every story, and while banks made control to whom they lend, they can only do so if there are people who want loans. 

Following the LVR policy implementation, prospective homebuyers may have begun to self-regulate.   Although banks could still allocate 10% of their lending to high-LVR loans, this was less than half of what they formerly allocated to the category.  Word that it was harder to get a mortgage with a sub 20% deposit soon turned into talk that a 20% deposit was a requirement.

People have an aversion to rejection, particularly when it comes at a cost. Applying for home loans takes a certain degree of effort.  If a prospective homebuyer thinks they won't get a loan with a less than 20% deposit, they either:

1.       don't bother applying in the first place, or

2.       wait until they can save up a larger deposit, or

3.       they source funding (eg from family) to top up their deposit

The first of these outcomes results in a lower number of people seeking low deposit home loans.  The latter two result in a transition of new mortgagees from the high-LVR category to the lower LVR categories.  All of these outcomes skew residential lending away from high-LVR loans. 

If there is a smaller proportion of low deposit homebuyers on the market, banks may not even be able to make 10% of their residential loans fit in the high-LVR category – even if they wanted to.