Increased capital requirements 'could make loans more expensive'

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Banks may soon have to hold more capital to offset high loan-to-value home lending, the Reserve Bank has indicated. And one expert says that may lead to higher interest rates.

Tuesday, March 26th 2013, 11:46AM 1 Comment

The Reserve Bank is reviewing the housing loan capital adequacy requirements for New Zealand banks and has released a consultation paper.

The requirements dictate how much a bank must have set aside to cover potential losses from mortgage lending.They are reviewed periodically.

Deputy governor Grant Spencer said the Reserve Bank wanted to ensure the requirements adequately reflected the risks involved in lending to the housing sector. "The bank is proposing higher capital requirements for high LVR loans."

The paper says borrowers with high LVR loans are more exposed to systemic risk than those with low LVR lending. "If economic conditions change for the worse, and in view of the current state of the housing market, there is a risk that borrowers most exposed to adverse changes in general economic conditions could all come under pressure at the same time, with a corresponding impact on the quality of banks’ housing loan portfolios. This is an important motivation for reviewing the balance between systemic and idiosyncratic risk within banks’ housing portfolios."

He said it made sense to get the requirements right before the Reserve Bank's proposed macroprudential tools kicked in.

Claire Matthews, of Massey University's Centre for Banking Studies, said permanently higher capital ratios would probably make home loans more expensive. She said one of the drivers in setting interest rates was covering the cost of holding capital. "This is likely to put up interest rates."

But she said Basel II had dropped capital requirements and this could in effect just return them to where they were. "Housing loans have had lower capital ratios because recent history has shown that home loans don't carry a lot of risk. There is some default but the rate is not high and is lower than other forms of lending."

Submissions are open until mid-April.

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