"The potential role of a macroprudential debt-to-income policy" is a topic allocated a break-out read in the Reserve Bank of New Zealand's latest Financial Stability Report. The FSR radiates a level of alarm over DTI lending practices."Borrowers with elevated DTI ratios are vulnerable to a period of reduced income or higher interest rates and can present a risk to the banking system and wider economy," the RBNZ said, leading into a discussion of "the possible role that a limit on high-DTI loans or a similar serviceability restriction could play in mitigating these risks, and how it would complement other macroprudential tools."A macroprudential DTI policy "would enable the [RBNZ] to limit the degree to which banks can reduce mortgage lending standards during periods of rising housing market risks, in order to protect financial system soundness," the regulator said."This may be desirable in periods where banks are not incentivised to adequately take account of the impact their lending can have on the overall financial system."The RBNZ added: "The economy can suffer if too many borrowers take on more debt than they are able to service. "DTI policies can support financial stability by reducing the scale of mortgage defaults during a severe economic downturn. "All else equal, borrowers with higher DTI ratios have less disposable income to draw on as a buffer to avoid defaulting on their mortgage, without selling their home, in a period of lost income or higher mortgage rates. Loan serviceability is a crucial determinant of probability of default, reflecting that many borrowers will attempt to service loans even if they are in a position of negative equity."Laying down a bleak scenario, the RBNZ said "forced house sales by high DTI borrowers would likely amplify house price declines, impair the ability of banks to resolve distressed loans, and increase loss given default for banks. "High DTI households are also likely to reduce consumption more sharply during a severe downturn, in an attempt to continue servicing loans and increase precautionary savings. "A number of studies have found that sharp falls in consumption by indebted households reinforced the economic impact of the GFC. There is also evidence that highly indebted households in New Zealand cut back on consumption more sharply than other households."DTI policies can complement other macro-prudential policies, including LVR policies."The RBNZ has now relied on macroprudential policy to patrol the upper bound on loan-to-valuation ratios and the central bank pitched an addition to its policy tool kit as a prop to its core remit, corralling inflation, maximising employment and assuring financial stability."DTI policies can increase the resilience of households to income shocks, reducing the number of forced house sales in a downturn, and LVR policies can increase the equity buffers of households, reducing the losses faced by banks if borrowers come under stress. "Using both policies at the same time is likely to achieve a more targeted response to rising housing market risks, given that both LVR and DTI ratios are important drivers of the scale of mortgage losses."