New Zealand limits risky mortgage lending to head off risk of bubble

New Zealand's central bank took a step in the dark yesterday when new rules to limit risky house lending came into effect, although many economists doubt they will work.

Meanwhile, struggling first-home buyers appear to have become the first casualties.

From yesterday, banks have to keep lending to borrowers with mortgage deposits of less than 20 per cent of a property's value - so-called high loan-to-value ratio lending (LVR) - to no more than 10 per cent of their total lending.

The Reserve Bank of New Zealand had been flagging for the past year its concern about the risks of an overheated housing market, particularly in the biggest city Auckland, and the risk that posed to the country's financial system if there should be sharp downturn.

"The LVR restrictions are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy," bank governor Graeme Wheeler said in his September 12 monetary statement.

By his own admission, Wheeler does not know if the measure will work and what impact it might have, although he has said the bank does not want to cool the housing market by raising its official cash rate because it might fuel buying of an already high New Zealand dollar.

Median house prices were at a record in August, having risen 9.5 per cent over the year, but in Auckland, where supply is heavily constrained, prices rose 17.9 per cent.

To some observers the bank's move is more like a policy stab in the dark, to cool a moderate housing market with two hot spots, Auckland and earthquake-damaged Christchurch.

"The Reserve Bank of New Zealand has moved into the realms of experimentation with its macro-prudential prescription," Stephen Toplis, the Bank of New Zealand's head of research, said.

The new rules, which apply only to retail banks, do not ban lending to homebuyers with less than a 20 per cent deposit. But banks which had as much as 60 per cent of new mortgages in such loans are now starting to charge a higher rate of interest compared to those with big deposits.

The LVR restrictions are untried in New Zealand, but have been used in several countries, including South Korea, Switzerland, Canada, Israel, and Sweden, with mixed results.

Westpac Bank economists surveyed the offshore experience, which shows fewer house sales, and price growth slowing and in some cases falling, but only for a limited period.

"The impact is likely to be quite modest, relatively brief, and less effective than moving interest rates would have been," Westpac senior economist Michael Gordon said.

The reserve bank has warned commercial banks not to try to get around the new rules, but already there are reports of borrowers chasing money from parents, using credit cards, or heading to more expensive non-bank lenders.

"By pushing people into the unsecured lending market you're not doing what you aim to, which is cooling demand, and if financial stability is the objective driving people into the unsecured lending is not the best way of that," the nation's Bankers' Association chief executive Kirk Hope said.