March 10, 2014 | Clancy Yeates | http://www.smh.com.au/business/banking-and-finance/rba-mulls-higher-home-loan-hurdles-to-curb-risky-lending-20140310-34gzt.html
The Reserve Bank’s preferred way of reining in a harmful housing credit boom would be to force banks to impose higher “buffers” when testing how borrowers coped with higher interest rates, new documents show. But unlike its counterpart in New Zealand, Australia’s central bank appears unconvinced about restricting loans with high loan-to-valuation ratios. With banks competing fiercely to sign up new borrowers, documents released under Freedom of Information laws on Monday show the Reserve Bank has examined various options for limiting riskier lending. An internal briefing note prepared by the head of the RBA’s financial stability department, Luci Ellis, said larger interest rate buffers were the ”most promising” policy for leaning on housing booms.
A “buffer” refers to a borrower’s ability to deal with an increase in interest rates throughout the life of the loan. For example, a bank may assess a borrower’s ability to repay a loan at an interest rate of 7 per cent, even though they had applied for a loan with a current interest rate of 5 per cent. The two percentage point “buffer” between the actual and increased rate helps ensure that borrowers will still be able to afford the loan in the event of future interest rate increases. ”Other than avoiding an over-easing of monetary policy, the most promising policy response seems to be to introduce a regulatory regime that automatically requires larger interest buffers in loan affordability calculations when interest rates are low,” Dr Ellis wrote in the briefing, dated July 19, 2013.
”This could be introduced either as a prudential measure or as part of the National Consumer Credit Code, or both.” The document is the latest sign the Reserve is considering ”macroprudential” policies, which constrain riskier lending in order to protect financial stability.
When banks are making new loans, they typically use a ”buffer” to test how a borrower would cope if interest rates rose by 200 basis points, or two percentage points. At a parliamentary hearing on Friday, governor Glenn Stevens also said the most effective macroprudential tool for Australia could be for banks to impose tougher ”buffers” for testing how new borrowers coped with higher interest rates.
Mr Stevens said that under the approach, the Australian Prudential Regulation Authority ”could insist that the test be made 300 higher, or 400, or whatever, so that people do not get overcommitted.” The bank’s deputy governor, Philip Lowe, told the same hearing there was ”quite a lot of merit” in exploring the policy.
”I think the benefit of that type approach is it allows lower interest rates to feed through into lower servicing costs for both new and existing borrowers, but it does not mean that lower interest rates keep on increasing the size of the loan that people can get access to, because the bank is applying a bigger buffer to the actual interest rate you pay,” Dr Lowe said.
The most commonly-discussed macroprudential policy is to limit loans with a high loan-to-valuation ratio – an approach used by governments in New Zealand, Canada, Sweden, Norway, Israel, Korea and Hong Kong. But the July briefing prepared by Dr Ellis argued that restrictions on high-LVR loans did not necessarily reduce risk in the financial system. This is because the people who take these loans out are often first home buyers, who are less likely to be speculating on house prices, the document said.
The discussion of ”macroprudential” policies comes despite ongoing improvement in Australian credit quality. Fitch Ratings last week said the share of borrowers falling behind on their repayments at the end of 2013 was at its lowest level in four years. However, the RBA and other regulators are wary of the risk that some borrowers tend to take on more debt than they can afford during a time of very low interest rates.