A Critical Analysis on the Effectiveness of Reserve Bank of New Zealand(RBNZ) Restrictions
After the Global Financial Crisis(GFC) in 2008, the Reserve Bank had to reduce their Official Cash Rate(OCR) from 8.25% to 2.50%. This was the only tool available to the then Governor Alan Bollard. From June 2008 to April 2009, the OCR was constantly reduced to 2.50% in order to prop up the economy. Prior to GFC, the house prices in Auckland doubled(From 2002 to 2008) in approximately 6 years. The OCR was introduced by the Reserve Bank in 1999.
In 2010, there were signs of an inflation in the house price, post the GFC. As a result, the OCR increased from 2.5% to 3%. However, in the following year it was reduced back to 2.5% due to the devastating earthquakes experienced throughout Canterbury.
But 2011 also saw our country host the Rugby World Cup. After the All Blacks beat France in the finals, there was a lot of economic activity, such as the rebuilding of Christchurch after the earthquakes, and a lot of investors showed interest in investing in Auckland, etc. This laid a strong foundation for further real estate activity compounded with a price surge in residential properties in Auckland.
To cool the price surge in properties, the RBNZ introduced 3 restrictions since 2013.
The total number of new residential mortgage lending for loans of over 80% Loan to Value Ratio (LVR) must not exceed 10% of the total new mortgage lending– Exemption applied for re finance of loans and newly constructed homes - came into force from 1st October 2013.
- Prior to introducing this restriction, the trading banks were offering approximately 31% of their total new lending to LVR loans of over 80%. Also, the OCR had jumped from 2.50% to 3.50%(Increased interest rates from March 2014 to July 2014)
- This restriction virtually reduced the no. of homes sold in the following months and to some extent the price surge was contained. But prices started to surge in late 2014 and further intensified in 2015.
- Currently in 2017, around 9% of total loans are over 80% LVR. Huge improvement considering the fact that the higher amount of LVR loans are successfully contained.
2nd restriction: 30% deposit requirement for new investment properties purchase in Auckland region and to continue with the first restriction – came into force from 1st October 2015.
- Prices surged in the peripheral areas of Auckland, such as Whangharei, Hamilton, Tauranga etc. Investors started to chase rental yields and lower value properties.
- Seasoned investors who had multiple properties and built a lot of equity with their Auckland homes were not affected much with the above restrictions.
- RBNZ had to reduce the OCR from 3.50% to 1.75%( The reduction of OCR started from April 2015 to November 2016)
3rd restriction: 40% deposit requirement for new investment properties purchased anywhere in New Zealand and to continue with first restriction – came into force from 1st October 2016.
- There was a drop in the number of homes sold, prices have stabilised and in some areas marginal price drops are seen currently.
- Though RBNZ have given some speed limits in the form of 5% of loans to investors can be over 60% LVR, the trading banks use this speed limits for customers who have to do regular maintenances for homes etc.
RBNZ have also indicated that they would like to have DTI’s(Debt to income ratio) to support the above restrictions, in case if price of homes surge again. The DTI in simple terms is described as a multiple factor of your income. For example if RBNZ wants DTI ratio to be less than 5 times your gross income, then the trading banks cannot give loans over 5 times of your gross income. For a household gross income of $120,000, the maximum loan the household can have is $120,000 x 5 = $600,000.
Is New Zealand at a cross road? After all these restrictions…
The simple answer is “NO”.
In a nutshell, the financial stability of the market has improved dramatically due to the above restrictions. Even if the house prices go down by say 5%, 10% or even 20%, i.e. a worst-case scenario, most of the current mortgages will not have any big issues, due to low interest rates and low loan to value ratio. If a downturn happens, this time around, clients are equipped with more information, planned exit strategies and they will have some savings in comparison to those who did not during the GFC. Hence, they can withstand such shocks. On the other hand the trading banks also have better ways to communicate with customer and manage their debt and arrears. Overall, the restrictions played their part and the household financial stability have improved substantially. Kudos to our current RBNZ Governor Graeme Wheeler.