DTIs need deeper analysis

A cost benefit analysis of debt-to-income restrictions needs to be done before they go any further, BusinessNZ says.

Wednesday, March 20th 2024, 7:43AM

The group says given the coalition Government’s emphasis on improving the quality and efficiency of regulation, it seems logical and desirable the Reserve Bank’s proposals are subject to thorough analysis.

It doesn’t believe there is a strong case for introducing DTIs as banks already have significant commercial incentives to stress test loans and ensure that defaults on loans are minimised.

“DTIs also disregard the many factors which a bank will consider when assessing the capacity of a borrower’s creditworthiness,” the lobby group says in its submission to the Reserve Bank on activating DTIs and loosening LVRs.

Stress tests of banks conducted by the RBNZ have repeatedly shown they are resilient to even severe house price shocks and sharp increases in the rate of unemployment.

It is also important to appreciate that any tools developed should be appropriate to deal with perceived risks associated with the financial system, BusinessNZ says.

Former Reserve Bank senior employee and economic and financial consultant Geoff Mortlock wrote in a recent article the most appropriate policies to address residential property price concerns lie outside of the RBNZ’s mandate.

He says for example, appropriate policies are likely to focus on: (a) increasing the allocation of urban land zoned for residential construction; (b) strengthening the capacity of the building sector to build more properties; (c) relaxing unnecessary building code and consent requirements; and (d) reducing the level of immigration. None of these policy issues lie within the remit of the RBNZ.”

Mortlock argues Finance Minister Nicola Willis should commission an independent review of the RBNZ's DTI policy coordinated by Treasury.

Only banks

As the proposed requirements are directed only to banks, it seems possible that other financial institutions will not be affected, a situation which can be considered inequitable and may encourage greater lending in less regulated sectors of the economy, which is not necessarily desirable, the group says.

Its general reluctance to support the activation of DTIs are particularly associated with the potential for unintended consequences, including, but not necessarily limited to, the following:

• Potentially adverse impact on particular groups;
• DTIs are a blunt tool for assessing financial risk;
• DTIs bear no relation to particular risks in particular areas;
• Pressures to seek alternative capital via, loan sharks, family etc;
• Impact on availability of small business finance; and
• Impact on efficiency if people undertake sub-optimal investments.

Impact on particular groups

While it almost a truism that the benefits of regulation must outweigh the costs in order for regulation to be justified, it is also important to analyse not only total costs and benefits (including potential unintended costs and/or benefits) but also where these expected costs and benefits might fall, Business NZ says.

For example, in the case of the DTIs, the benefits (if any) of this proposal might be widely dispersed but the costs will fall disproportionately on one group (lower income earners).

“There are a number of benefits associated with homeownership and restricting the ability of certain groups to enter the market without adequate cause is problematic,” the lobby group says.

Blunt tool for assessing risk

As DTI settings may bear no relationship to serviceability of loans to specific individuals, they are a crude and rather blunt instrument for assessing risk.

Delaying making an investment decision may impact adversely on specific individuals.

They are a very crude and blunt tool for assessing individual risk.

It could be argued individuals with lower income levels impose a higher risk, but it is also an issue of determining lifetime earnings/consumption profiles and other assets which are arguably more important than DTIs.

An individual or family might have assets which they do not wish to cash up (for a variety of reasons), so DTI will have little if any value in determining risk, apart from a generalised assumption that those individuals obtaining high DTI loans are inherently a “bad risk.

The full picture of an individual’s net worth and earnings potential is probably much more relevant in determining risk than are DTIs.

Impact on availability of small business finance

Many small business owners use housing mortgage finance to partially fund business activities, BusinessNZ says.

They may do this for a number of reasons including, but not limited to, the fact that housing mortgage finance is generally less costly than business finance.

By, in effect, restricting this source of finance, the ability of many small business ventures to get off the ground could be unnecessarily restricted.

Binding level

The group says as the proposed DTI restrictions are likely to go ahead, it agrees with the concept of setting them at a level which is binding during a boom but has limited or no effect during normal times.

“It is appropriate to introduce them as soon as practically possible to ensure that current and future residential households and investors are minimally affected by the changes.

“It then allows adequate time for households and investors to adjust their behaviour if necessary, without having to drastically change short-term plans,” BusinessNZ says.

Tags: DTIs