Puzzle Finance Blog

Regulators should target loan serviceability to head off trouble

ALMOST out of nowhere, it seems, international regulators are not just talking about macroprudential controls over bank lending but introducing them.

There is now mounting pressure on the Australian Prudential Regulation Authority to follow suit.

Despite the host of new regulatory requirements imposing higher capital requirements, leverage ratios, tougher liquidity rules and the like since the global financial crisis, there is a significant push on for another layer of regulation.

In New Zealand, Norway, Sweden, Switzerland and Canada, new restrictions on high loan-to-valuation-ratio lending have already been introduced, while Britain is contemplating whether it needs to act.

The push for this extra layer of regulation, of home lending in particular, stems from fears that new asset bubbles are emerging within developed economy housing markets.

In a sense, the debate about macroprudential policies is an old one with a new label. For more than a decade there has been an inconclusive discussion among central bankers and the bank regulator about the merits of trying to head off (or "lean" against) developing asset bubbles.

That does, of course, presuppose that regulators can identify a developing bubble, something our Reserve Bank hasn't been totally convinced is possible.

The tools the regulators (including the International Monetary Fund) are promoting are restrictions on loan-to-valuation ratios, counter-cyclical capital buffers, loan-servicing limits and the like. It is interesting that most of the discussion and the actions relate to housing markets and concerns they may overheat as a result of the extended period of low interest rates throughout the developed world.

There is, of course, a broader concern about asset price bubbles generally because of the continuing flood of cheap liquidity that has poured through global markets since the crisis.

As long as the US's quantitative easing -- which has seen the Fed's balance sheet expand by nearly $US3 trillion ($3.21 trillion) since the program started -- and low rates remain in place globally, there will be a continuing pursuit of higher yielding and riskier assets and the prospect of asset bubbles across a range of markets.

Lending for housing is at the heart of the new round of regulation. It was collapses in housing markets in the US, Britain, Spain, Ireland and elsewhere that inflicted real damage on those economies and their financial institutions.

It may also be that bubbles in other asset classes are more difficult to manage via macroprudential tools.

In this market, where the banks' balance sheets look more like those of giant building societies, stuffed full of residential mortgages, the fixation with lending for housing and the state of that markets is perhaps more understandable. It is not clear, though, how fiddling with loan-to-valuation ratios properly heads off the threat of a housing bubble.

Rationing high-LVR lending, as New Zealand has done, may reduce the flow of funds into that segment at the margin, but the denominator in an LVR is an asset price and trying to determine whether asset prices are in bubble territory is almost impossible except with hindsight.

The focus, particularly in this market where borrowers can't walk away from their mortgages, should not be so much on whether banks are lending at high LVRs -- as only a relatively small proportion of new lending is at LVRs above 90 per cent -- as on the actual serviceability of the loan.

APRA has, appropriately, reminded the banks to lend prudently.

The other problem with a macroprudential approach is that, in most developed financial systems, there are heavily regulated institutions such as banks and then quite lightly regulated non-bank entities.

While the priority is to ensure the stability of the banking system, regulators would be very conscious, particularly after the financial crisis, of the risk of pushing risks into the shadow banking sector, where they are not visible, let alone effectively regulated.

For the moment, however, regulators don't have a lot of options. They know the prolonged and still-lengthening period of historically low interest rates does promote asset prices bubbles and risk-taking behaviour that in a different rate environment could come back to haunt lenders, borrowers and regulators.

In the circumstances it might be better to do something rather than nothing.

Conventionally, the way to head off a housing market bubble would be to raise interest rates but, in the case of APRA and the Reserve Bank, they know that is not an option while the economy remains weak and the dollar remains strong.

What they (and every other regulator and finance minister around the globe) ought to be doing is urging the US to wean itself off the increasingly ineffective QE program as soon as practicable before the imbalances it has created, and is creating, around the globe lay the foundations for another major financial crisis.


Stephen Bartholomeusz is a columnist for Business Spectator. For more commentary visit www.businessspectator.com.au.

Posted by Stephen Bartholomesz - The Australian on 19th September, 2013 | Comments | Trackbacks

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