Regulation on requirements for new residential mortgage loans
Norges Bank's letter of 17 August 2016 to the Financial Supervisory Authority of Norway
Norges Bank refers to Finanstilsynet’s (Financial Supervisory Authority of Norway) letter of 24 June 2016 regarding “Assessments of the regulation on requirements for new residential mortgage loans and household debt growth”. In the letter, Finanstilsynet writes:
“Finanstilsynet requests that Norges Bank provide an [..] assessment of house price inflation and growth in household debt in Norway and of how the regulation on requirements for new residential mortgage loans has affected these developments”.
The regulation on requirements for new residential mortgage loans came into effect on 1 July 2015 and applies until the end of 2016. The adoption of the regulation was preceded by a consultation based on a proposal prepared by Finanstilsynet. Norges Bank took part in the consultation.
The main requirements set in the regulation are: 1) the LTV ratio should be capped at 85 percent, 2) a borrower’s debt-servicing capacity should be stress tested against a 5 percentage point rise in mortgage rates and 3) principal repayments should be required for loans with an LTV ratio above 70 percent. The regulation allows for up to 10 percent of the volume of a bank’s approved mortgage loans per quarter to be loans that do not meet one or more of the requirements, referred to as a “speed limit”.
Capital requirements for Norwegian banks have been raised in recent years. This has increased banks’ resilience to future loan losses and may mitigate the risk of a credit-driven downturn in the Norwegian economy. Requirements for banks’ credit standards may also reduce the share of particularly vulnerable households.
Developments in the housing market and household debt
House prices have risen 11 percent more than per capita disposable income since spring 2008. A house price correction could lead vulnerable households with high levels of debt to reduce their consumption. This could amplify a downturn in the Norwegian economy. The share of households with particularly high debt ratios has risen every year since the financial crisis, especially in the youngest age groups.[i]
Norwegian household debt growth has slowed somewhat since the regulation came into effect, but debt has continued to rise at a faster pace than income. A regression analysis based on regional house price and unemployment figures, lending rates and the timing of the change in lending requirements suggests that the lending requirements have probably had a limited effect on house prices.[ii] House price inflation slowed through autumn 2015, but has picked up in the past six months. At the national level, house prices are now 9 percent higher than they were a year ago. In Oslo, prices have risen by 15 percent. At the same time, there are wide regional differences in the housing market, with falling or stagnating prices in the counties of Rogaland and Agder.
Results from Finanstilsynet’s 2015 residential mortgage lending survey, Finanstilsynet’s supervision and Norges Bank’s survey of bank lending, indicate that banks have been somewhat more restrictive in their credit standards for particularly vulnerable households in the period following the introduction of the regulation on requirements for new residential mortgage loans. Finanstilsynet’s annual residential mortgage lending survey covers around 90 percent of the mortgage loans approved in the Norwegian banking market in a given period. In the 2014 survey, 10 percent of these loans were amortising loans with LTV ratios above 85 percent when additional collateral is taken into account. In the 2015 survey, this share declined to 7 percent. The shares of interest-only loans and loans that did not meet the requirement relating to debt-servicing capacity also fell somewhat between 2014 and 2015. According to information obtained during Finanstilsynet’s supervisory activities, banks report that 6.1 percent of all new loans were in breach of the overall requirements in 2016 Q1. The banks in Norges Bank’s survey of bank lending have reported tighter loan conditions relating to LTV ratios, debt ratios and principal repayments.
Tighter credit standards may lead younger home buyers in particular to buy cheaper dwellings or to delay buying. A preliminary analysis of housing transaction data shows that the spending behaviour of the average home buyer in the youngest age groups has not changed substantially in the period between 2007 and 2016.[iii] Younger home buyers buy dwellings of approximately the same size today as in 2007, they buy dwellings at about the same age and purchase prices have developed in line with the average. Thus, there is no clear indication so far that housing market demand among younger home buyers has diminished. The data set does not cover the use of additional collateral.
Consumer debt has shown a sharp rise in the past year, but continues to be a small share of total debt. Norges Bank does not have adequate data to analyse whether unsecured consumer loans are increasingly being used as top-up financing for home purchases.
Norges Bank will continue its work on these issues and communicate any results to Finanstilsynet in the course of August.
Accelerating house price inflation and the continued rise in household debt ratios may suggest that the regulation has so far had a limited effect on house prices and total credit.[iv] Nevertheless, there are signs of somewhat more restrictive bank credit standards and some decline in loans with particularly high LTV ratios.[v]
In its consultation response dated 4 May 2015, Norges Bank presented analyses of debt for households with LTV ratios above 85 percent, with weak debt-servicing capacity and/or high LTV ratios with interest-only periods. The analyses used data for household income, debt and housing wealth based on tax assessment data for 2013.[vi] According to the data, the LTV requirement was the requirement with the greatest impact. If household borrowing had been limited by strictly applying all the requirements, the tax assessment data suggested that household debt growth in 2013 would have been substantially reduced.[vii] An updated analysis based on tax assessment data for 2014 shows approximately the same result.
The regulation currently sets a “speed limit” allowing 10 percent of new loans to breach one or more of the requirements in the regulation. Norges Bank notes that 6.1 percent of new loans did not comply with one or more of the requirements in the current regulation at the end of 2016 Q1. A speed limit in the lower portion of the interval, as outlined by Norges Bank in its consultation response, could have some dampening effect on borrowing. Such an adjustment will still provide banks with flexibility, while at the same time requiring banks to restrict the share of loans with a high probability of default somewhat more than is the case today. The analyses referred to above suggest that setting the speed limit at zero could have a considerable impact on borrowing. On the other hand, setting the speed limit at zero could have unintended effects on efficiency and distribution. Any adjustment of the speed limit must be viewed in the light of the other requirements in the regulation.
The regulation is primarily designed to dampen the risk of a substantial rise in debt held by particularly vulnerable households, thus preventing future slippage in credit standards. If the measures also dampen the overall rise in debt and house prices, this effect will likely only become evident over some time. Norges Bank refers to its consultation response of 4 May: “[…] requirements for prudent lending should be regarded as a permanent structural measure […]”.
- Particularly high debt ratios are defined here as debt in excess of five times annual income.
- Lending requirements are modelled as time dummies for when the requirements were introduced. These are slightly negative, which means that house prices declined somewhat after these dates, but we cannot identify with certainty the extent to which this can be attributed to tighter lending conditions.
- The analysis is based on property information as registered in the Land Registry (via Ambita) and homebuyers’ ages as recorded in the tax register. Figures as at January 2016.
- International studies have also shown that requirements for credit standards have had an effect on debt growth and to some extent on house price inflation, see for example Jácome, L.I. and S. Mitra (2015), Cerutti, E., S. Claessens and L. Laeven (2015), and Tressel, T. and Y.S. Zhang (2016).
- An analysis of homebuyers’ LTV ratios using data from Ambita and tax assessment statistics show some effect around the LTV cap when the guidelines for prudent mortgage lending were introduced in 2010 and changed in 2011.
- The analyses were based on Finanstilsynet’s proposed caps. The proposed caps were somewhat more stringent than those adopted, but these differences have little significance for the results of the analysis. Finanstilsynet proposed that the requirements should be laid down in a regulation, in general without a speed limit.
- There is considerable uncertainty around the calculations. Tax assessment figures, for example, include consumer debt, which is not covered by the regulation, and the figures do not provide any information about additional collateral. In addition, estimated market values for housing probably underestimate actual market values. The analyses are described in more detail in the attachment to Norges Bank’s consultation response of 4 May 2015.