Assessment of the regulation on requirements for new residential mortgage loans
Norges Bank's letter of 9 February 2018 to the Financial Supervisory Authority of Norway
Norges Bank refers to the letter from Finanstilsynet (Financial Supervisory Authority of Norway) of 15 November 2017 on “Assessment of the regulation on requirements for new residential mortgage loans”. In the letter, Finanstilsynet refers to the Ministry of Finance’s letter of 6 November in which the Ministry writes:
The Ministry of Finance requests that Finanstilsynet perform an assessment of developments in house prices and Norwegian household debt and of the impact of the regulation on requirements for new residential mortgage loans on these developments. We also ask that Finanstilsynet assess how the regulation has impacted bank lending standards and the effects of the separate requirements in Oslo. In this work, we ask that Finanstilsynet obtain assessments and a body of evidence from Norges Bank.
In its letter to Norges Bank, Finanstilsynet writes:
Finanstilsynet requests that Norges Bank perform assessments of the issues listed above and, in particular, assessments of the rise in house prices and in Norwegian household debt, and how the regulation has impacted these developments.
The current regulation on requirements for new residential mortgage loans entered into force on 1 January 2017 and applies until 30 June 2018. Prior to the new regulation, there was a consultation round based on a proposal prepared by the Ministry of Finance in which Norges Bank participated.
The requirements in the current regulation primarily entail 1) a loan-to-value (LTV) ratio limit of 85 percent of the value of the dwelling, 2) limiting borrowers’ total debt to five times gross annual income (debt-to-income (DTI) ratio), 3) testing borrowers’ debt-servicing capacity in the event of a 5 percentage point rise in interest rates, 4) principal repayment requirements for loans with an LTV ratio above 60 percent, and 5) an additional LTV limit of 60 percent for loans for secondary dwellings in Oslo. Up to 10 percent of the value of gross loan volume granted per quarter can be loans that do not satisfy one or more of these requirements, a so-called speed limit. The speed limit for residential mortgage lending in Oslo is 8 percent.
Requirements for banks’ residential mortgage lending were first laid down in regulation on 1 July 2015. A maximum debt-to-income (DTI) ratio and the requirements for lending in Oslo were not part of the first regulation. The principal repayment requirement was also tightened. The requirement was originally intended for mortgages with LTV ratios above 70 percent.
Developments in house prices, household debt and banks’ lending standards
The ratio of house prices to per capita disposable income increased by 35 percentage points from the end of 2008 to spring 2017. From then until autumn 2017, falling house prices contributed to a reversal of this development by five percentage points. The stock of homes for sale and selling times rose markedly in 2017, but turnover held steady. House prices rose more in Oslo than in other regions in 2016, and in 2017 the decline was also more pronounced in Oslo. In all large cities, the decline had been sharpest for flats.
Twelve-month growth in household credit generally remained at around 6½ percent since the introduction of the first regulation in July 2015 and through December 2017. Household debt as a percentage of disposable income continued to increase and was close to 225 percent in 2017 Q3.
Results from Finanstilsynet’s residential mortgage lending survey for 2017 and Norges Bank’s Survey of Bank Lending indicate that banks have had more restrictive lending standards since the tightening of the regulation on new residential mortgage loans in 2017. A comparison of residential mortgage lending surveys from last autumn and the previous autumn shows an increase in the share of loans that meet all the requirements introduced in 2017. The share of loans satisfying every single requirement increased. Overall, 7.3 percent of all new loans breached one or more requirements. For younger borrowers (under 30 years of age), 16 percent of new loans were in breach of requirements. At the same time, the share of loans in breach of requirements was particularly reduced among younger borrowers. According to Norges Bank’s lending survey, the implementation of a DTI limit is considered by banks to have had the most pronounced tightening effect, followed by the lowering of the LTV limit for secondary home purchases in Oslo and the lower speed limit in Oslo. Regional banks with low exposures to Oslo in their total mortgage portfolios in particular report that they are affected by the speed limit in Oslo. The lowering of LTV ratio limits on home equity lines of credit was ranked lowest.
For lower-income households, debt-servicing requirements appear to be the most important constraint on borrowing, while the maximum DTI ratio requirement appears to be the most important constraint for higher-income households. An analysis conducted by Norges Bank shows that for a large share of newly established young households, borrowing limits will be restricted by the maximum DTI ratio requirement. For couples under 30 years of age without children and for married couples with children under 5 years of age, this is the limiting requirement for over half of households in both groups.
Stricter requirements for lending standards can affect house prices. Preliminary analyses by Norges Bank of house price developments show that the introduction of the maximum DTI ratio requirement has dampened house price inflation, particularly in regions with high shares of homebuyers with high DTI ratios. The figures show a decline in the number of homebuyers in Oslo and among younger homebuyers in the country overall.,
High household debt is a source of vulnerability for the Norwegian economy (see the 2017 Financial Stability Report). Many households may need to reduce consumption in the event of a pronounced decline in house prices, a loss of income or a rise in lending rates. This may amplify a downturn in the Norwegian economy and increase banks’ losses on commercial loans.
Capital requirements for banks have been raised considerably since the financial crisis and have boosted banks’ resilience to declines in house prices and household consumption. Requirements for lending standards have a more direct impact on household borrowing and may reduce the share of vulnerable households. Such requirements should primarily contribute to mitigating the risk of rapid debt accumulation among particularly vulnerable households, while not necessarily impacting total debt. The authorities’ aim should not be to fine-tune developments in house prices and credit.
Strict requirements for lending standards limit the room for judgement in bank lending. Standardised requirements may have undesirable consequences in individual cases and restrict lending that is associated with low risk. For that reason, Norges Bank is of the opinion that requirements for lending standards should be laid down as guidelines or as a regulation with a speed limit. A speed limit gives banks room for judgement in applying the regulation.
A number of developments suggest that the regulation has had an effect on developments in lending and house prices. According to figures from the residential mortgage lending survey, there has been a decline in the share of loans in breach of the requirements. The regulation has likely contributed to the fall in house prices, but the decline in house prices must also be viewed in the context of the sharp rise in prices that preceded the tightening in 2017 and the increased stock of homes for sale. Low house price inflation will curb debt growth and may over time reduce vulnerabilities in the household sector. The recent correction in the housing market may lower the risk of an abrupt and more pronounced decline further ahead.
Norges Bank is of the opinion that statutory rules with a speed limit have functioned well. The regulation has provided clear prudent lending limits and has likely strengthened banks’ control over lending to vulnerable households. Banks have availed themselves of the speed limit to grant loans in breach of the requirements. A transition to guidelines may be considered in the period ahead, but banks and the authorities would then need to have an accurate and up-to-date picture of lending standards and household sector vulnerabilities by establishing a credit register, for example.
In its effect, the maximum DTI ratio requirement appears to have complemented the other requirements in the regulation. A DTI ratio requirement sets a clear limit on borrowing in relation to income, and can contribute to reducing the further build-up of household sector vulnerabilities when house prices are high, lending rates are low and the debt level in the household sector is high. The debt-servicing capacity requirement helps to ensure that borrowers are able to service their debt, even in a stress situation, but it acts as less of a constraint on maximum borrowing by high-income groups. LTV ratio requirements provide a margin of safety for individual borrowers and banks, but act as less of a constraint on maximum borrowing when house prices rise sharply. Principal payment requirements contribute to a reduction of loans with high LTV ratios over time. The residential mortgage lending survey shows that the share of loans granted with interest-only periods and LTV ratios over 60 percent declined in 2017, although it is difficult to assess the degree to which this is solely a result of stricter limits for interest-only periods.
The particularly sharp fall in house prices in Oslo probably reflects the fact that a larger share of homebuyers in Oslo have high DTI ratios compared with the rest of the country. These homebuyers will to a greater degree be affected by the DTI requirement. In addition, specific requirements related to residential mortgage loans in Oslo may have had an effect. The fall in prices in Oslo may also reflect a correction following the previous year’s rapid rise. There is reason to believe that the DTI ratio requirement can limit borrowing related to home purchases as investments.
Norges Bank refers to its consultation letter of 4 May 2015, in which we expressed that “[...] requirements for prudent lending should be regarded as a permanent structural measure, and should not be changed frequently”. A permanent, structural measure will contribute to predictability and counteract future deterioration of lending standards. The requirements in the regulation should as a rule be permanent. Adjustments can be made by changing the speed limit.
In the view of Norges Bank, the regulation should be retained in its current form, but without the specific requirements for Oslo. The speed limit seems well adapted to today’s situation.
- The analyses utilise regional variation in the share of homebuyers that are bound by the DTI ratio requirement. Norway is divided into 57 regions, and the share of homebuyers that breached current DTI ratio requirements in 2014 is calculated using tax assessment data from Statistics Norway and information on housing market turnover from Ambita. Regions with a high share of homebuyers that have breached the DTI ratio requirement have had weaker house price developments in 2017, controlled for developments in unemployment and the stock of existing homes for sale. In the analyses of changes in the number of homebuyers, information on housing market turnover between 2010 and the end of November 2017 is used. Private individuals that have purchased more than 25 percent of a property sold on the open market, are classified as homebuyers.
- International studies have shown that requirements for lending standards have had an effect on debt growth and to some extent house price inflation (see eg Jácome, L.I. and S. Mitra (2015), Cerutti, E., S. Claessens and L. Laeven (2015), Tressel, T. and Y.S. Zhang (2016) and Shim, I. and K.N. Kuttner (2016)). Such regulation has the most pronounced impact in periods of credit growth and rising house prices. For advanced economies, effects of relaxing such regulation in periods of declining credit and house prices have not been found to the same extent. This may be because there are fewer such episodes.