Bigger interest rate buffers the preferred macroprudential tool
Should the banking regulator and the central bank decide to add macropudential tools to their regulatory toolkit the most likely choice would be a higher interest rate buffer, according to JP Morgan banking analyst Scott Manning.Manning included an exhaustive search of the Reserve Bank's musings on the macropudential question in the latest JP Morgan mortgage market report. He found that, at one time or another, the RBA has criticised most of the tools on offer.Macroprudential policy involves the use of a set of non-interest rate tools to stabilise house prices and housing credit. These tools include reserve requirements, maximum debt service-to-income ratios, maximum loan-to-valuation ratios, limits on exposure to the housing sector and housing-related taxes.The Reserve Bank of New Zealand introduced macroprudential policy last year, limiting the amount of new mortgage lending above a loan-to-valuation ratio of 80 per cent.In a report published last November, the Bank of International Settlements said the problem with LVR limits was that housing credit would continue to rise with house price growth. That is, if the maximum LVR is 80 per cent, as long as house prices increase households will be able to increase their borrowings.In March, the RBA released several papers on macroprudential policy by the head of the RBA's financial stability department, Luci Ellis. Among her observations, Ellis said there had been insufficient independent evaluation of the effectiveness of macroprudential policies and that some influential papers on the matter had not been subject to peer review.Ellis said: "A uniform ceiling on debt servicing ratios, for example, ignores that different borrowers may have different servicing capacities out of the same income because their other obligations and circumstances differ. Competent lenders take account of these differences."Also in March, RBA governor Glenn Stevens told the House of Representatives economic committee that the most useful tool might be to increase the interest rate buffer that lenders use when they test a borrower's ability to continue servicing a loan when rates rise.Stevens said: "On the work that I have seen the most effective tool could be that when banks test people for an interest rate, so you are supposed to be able to make the payments not just at the current rate but, say, 200 points higher, APRA could insist that the test be made 300 higher, or 400 or whatever, so that people do not get overcommitted."According to Manning's research, the RBA's view on LVR caps is that borrowers who typically take out high LVR loans (such as first-home buyers) are not the main source of risks to financial stability or speculative pressure on house prices.Loan-to-income limits are hard to implement effectively because of the marked regional variations in house prices and incomes.Countercyclical buffers are "prone to leakage through regulatory arbitrage", which means that such buffers would only apply to prudentially regulated lenders.Taxation measures to dampen market activity, such as stamp duty, would only work as a one-off fix rather than a countercyclical tool.