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New Zealand may limit debt-to-income ratios to mitigate mortgage lending risk

New Zealand's central bank has proposed the use of the debt-to-income ratio as a policy tool to be included in a macroprudential framework aimed at mitigating financial risks caused by excessive mortgage lending.

New Zealand borrowers' debt-to-income ratios on loans have risen sharply over the past 30 or so years, reflecting partly a drop in interest rates over time. However, interest rates could rise sharply and bring about a negative shock to borrowers' incomes, according to a consultation paper released June 8.

The Reserve Bank of New Zealand plans to introduce a limit on debt-to-income ratios to restrict the amount of loans that mortgage borrowers can take out relative to their income, to reduce the risk of default payments. The restriction on mortgage lending may prevent about 10,000 borrowers from buying a house, reduce house sales volumes by about 9%, and trim house prices and credit growth by up to 5%.

The central bank said the application of a debt-to-income ratio limit would be similar to loan-to-value ratio restrictions that it introduced in 2013, and may also have similar exemptions. The limit may allow lenders to employ a "speed limit," under which they can undertake a proportion of loans at debt-to-income ratios above the chosen threshold.

The limit, if applied in appropriate situations, is expected to reduce the overall risk of dysfunction in the mortgage and housing markets in a severe downturn instead of just protecting individual borrowers.

The new measures are expected to reduce financial distress in tough economic situations, reduce the magnitude of an economic downturn and help to constrain the credit-asset price cycle better than other macroprudential tools.

The complete macroprudential framework will be reviewed in 2018. The central bank is seeking comments on the consultation paper until Aug. 18.