Downside risk in use of macro-prudential tools, warns RBNZ

Yanking the levers of the banking system to choke off a credit cycle boom requires care, since there’s no guarantee how people will start borrowing again once the lever is released, the Reserve Bank of New Zealand says.

“A counter-cyclical buffer would be ‘released’ when there were clear signs the credit cycle had peaked,” the central bank says in a 12 page consultation paper laying out options for the use of so-called “macro-prudential tools” to complement the inflation-targeting primacy of monetary policy.

The bank warns that “timing such reversals may be technically difficult and may conflict with the natural tendency of lenders and financial markets to become more risk averse during a downturn.” “It may be easier to lean against credit booms than it is to encourage lending in a downturn. That could make macro-prudential tools asymmetrical in their effect.” Intended to stop the kind of credit bubble that underlay the global financial crisis of the last five years, the new tools are being implemented globally and the RBNZ is already committed to a Jan 1, 2014, implementation of counter-cyclical capital buffers (CCB).

These are the longest-acting new policies available to central banks to discourage excitable lending, requiring 12 months for banks to implement because of the implications for balance sheet restructuring. The next longest lead-time belongs to adjustments to core funding ratios, requiring six months, flowed by sectoral capital requirements where, say, farm or home lending segments of banks’ portfolios needed greater capital support, requiring three months’ notice.

The fastest-acting lever available is alteration of loan-to-value ratios (LVR’s) to prevent banks making new loans above a certain threshold without deposit. That would require just two weeks’ notice and would only change the behaviour of current buyers, who would suddenly need more capital than expected. With house prices leaping in Auckland and Christchurch beyond pre-GFC boom-time levels, the bank has faced calls to use LVR’s to tweak home buyers’ behaviour when the market looks too hot.

However, the RBNZ suggests there are numerous problems with LVR’s, including that many people would simply borrow in the less regulated parts of the finance sector. “The bank might need to investigate the possibility of extending the perimeter of macro-prudential regulation.” The RBNZ is preparing to sign a memorandum of understanding with the Treasury and the Minister of Finance, governing how it will be allowed to use the powerful new monetary system levers.

However, it warns the tools cannot be expected to fix economic imbalances, if they stem from “a mis-calibration of other policies.” “Macro-prudential instruments will not be applied in a formulaic manner; they will be applied in a forward-looking manner, and they will not affect existing loan agreements,” the consultation document says. Submissions are due by April 10. (BusinessDesk)