Housing has been a front of mind issue for the November FSR
The resilience of New Zealand’s financial system has been described as ‘reassuring’ by the Reserve Bank, with governor Adrian Orr saying that it as “well placed to support economic recovery, despite uncertainty and risks.”
The Reserve Bank has released its November Financial Stability Report, and Adrian Orr said that despite the “significant challenges” of the ongoing COVID-19 pandemic, global economic activity has continued to expand. He noted that New Zealand had managed to get its activity back to pre-pandemic levels before the Delta outbreak, though the subsequent lockdown has created a lot of stress - particularly in the Auckland region.
Housing was also a key focus of Orr’s speech, and he said that the Reserve Bank will soon be consulting on using debt servicing restrictions to address housing risks - however, he noted that this is likely to take some time, as it would take banks around six months to implement any restrictions once they have been designed.
“Global economic activity continues to expand, albeit with significant challenges in large part due to the ongoing COVID-19 virus,” Orr said.
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“With the risk of global inflation heightened, already stretched asset prices are facing headwinds from rising global interest rates.”
“While Loan-to-value ratio (LVR) restrictions have been the main tool we have used to address housing risks, we will soon consult on the merits of implementing debt servicing restrictions to lean against these risks,” he explained.
“Meanwhile, we expect banks to be more cautious about high debt-to-income loans given the risks of rising interest rates and to the economic outlook.”
“Low interest rates during the COVID-19 pandemic have seen debt servicing costs decline, increasing borrowing capacity and the share of new lending at high debt-to-income (DTI) ratios,” he said.
“This is potentially leading to an accumulation of longer-term servicing vulnerabilities. We will soon consult on forms of debt servicing restrictions which could be used to lean against this type of risk.”
Climate-related risks were also identified as a key priority, and deputy governor Geoff Bascand said the Reserve Bank’s 2021 stress testing programme would consider the impact of draughts and weather events on banks and insurers, including their impacts on capital and profitability.
He also noted that some banks have already been lifting their capital levels in anticipation of increased requirements - something he said was ‘encouraging’, given the ongoing need for strong capital buffers.
“The unpredictable nature of future economic stresses reiterates the importance of resilience for our financial institutions so that they are in a strong position to keep supporting their customers and the economy,” Bascand said.
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“Our 2021 stress test of large banks to a severe but plausible economic downturn highlights growing resilience as capital levels have lifted. Capital requirements for banks will progressively increase from 1 July 2022, and it is encouraging to see them increasing ahead of these requirements.
“We also intend to increase the minimum core funding ratio (CFR) requirement to its previous level of 75 percent on 1 January 2022, subject to no significant worsening in economic conditions.”
Commenting on the November FSR, ASB chief economist Nick Tuffley said it is clear that the pandemic is renewing pressures on the economy - however, it is also highlighting its plans to strengthen bank capital requirements, as well as its intention to develop new macro-prudential measures to mitigate the housing-related risks.
“Housing-related financial stability risks remain front of mind, as flagged in yesterday’s RBNZ speech,” Tuffley said.
“In time, the RBNZ is likely develop a DTI tool – something it has wanted to for some time – and will also look at putting in place an interest rate floor for the calculations of interest serviceability.
“With consultation yet to occur, implementation of any new macro-prudential measures is roughly 6 months or more away,” he explained
“The direct impacts on borrowers of any forthcoming measures are, therefore, still some time away, though the RBNZ does “expect banks to be more cautious about high debt-to-income loans given the risks of rising interest rates and to the economic outlook”.”
“The changes announced today reinforce RBNZ efforts to rein in the housing market via conventional measures,” Tuffley concluded.
“We expect a further 150bps of OCR hikes and a 2% OCR endpoint, which should increase borrowing costs. Mortgage interest rates are already moving up, and are likely to increase further.”
