Norges Bank’s consultation response – amendments to and retention of the regulation on new residential mortgage loans
Norges Bank's letter of 11 April 2018 to the Ministry of Finance
Norges Bank refers to the consultation letter of 28 February 2018 from the Ministry of Finance requesting comments on the proposal by Finanstilsynet (Financial Supervisory Authority of Norway) to retain the regulation on bank credit standards with some amendments. The current regulation entered into force on 1 January 2017 and applies until 30 June 2018. Norges Bank also refers to its letter of 9 February 2018 to Finanstilsynet containing the Bank’s assessment of the regulation. (The letter is part of the consultation document including a proposal for a new regulation.)
Household debt in Norway has long risen faster than income. Although there is substantial equity in the household sector as a whole, it is primarily in the form of housing wealth. Many households may have to tighten consumption if house prices fall sharply, income declines or bank lending rates rise. This could amplify a downturn in the Norwegian economy and increase bank losses on loans to the corporate sector.
There is a two-way interaction between house prices and credit. High house price inflation can lead to higher household borrowing. House prices rose sharply for a long period. Twelve-month house price inflation slowed through 2017 and turned negative towards the end of 2017. In recent months, the decline in twelve-month house price inflation has levelled off.
Capital requirements for banks have risen substantially since the financial crisis and have increased banks’ resilience to losses owing to factors such as a fall in house prices or household consumption. Credit standards have a more direct impact on household borrowing and can reduce the share of vulnerable households. Such standards should primarily dampen the risk of rapid debt accumulation among particularly vulnerable households.
Effects of the current regulation
The results of Finanstilsynet’s residential mortgage lending survey for 2017 and Norges Bank’s bank lending survey indicate that banks’ credit standards have been more stringent since the regulation on new residential mortgage loans was tightened in 2017. According to figures from the mortgage lending survey, the share of loans that do not meet the required standards has decreased. According to the banks in Norges Bank’s lending survey, the introduction of a limit on the DTI ratio has had the strongest impact on household borrowing, followed by the lower LTV limit for secondary home mortgages in Oslo and a lower speed limit for Oslo. Regional banks in particular with only a small share of their total loans in Oslo report that the speed limit in Oslo is having an impact. The reduction of the LTV limit for home equity loans is ranked lowest.
Lower income households’ ability to borrow is most affected by the debt-servicing capacity requirement, while the limit on the DTI ratio has the most impact on higher income households.
More stringent credit standard regulation can affect the development in house prices and credit. Preliminary analyses carried out by Norges Bank on house price developments show that the introduction of the maximum DTI ratio has curbed house price inflation, particularly in regions with a large share of homebuyers with high DTI ratios. The fall in house prices in autumn 2017 must also be viewed in the context of the increase in the supply of dwellings and the high level of house price inflation that preceded it. The price fall through 2017 was strongest in Oslo, where house price inflation showed the steepest rise in 2016. Analyses show that credit growth in 2017 was lower in regions with a large share of homebuyers with high DTI ratios.
Norges Bank’s assessment
Credit market regulation must strike a balance between the aim of credit market efficiency and the aim of mitigating the build-up of risk in the financial system. Credit standard regulation can dampen the build-up of vulnerability among highly indebted households. Stringent credit standard regulation leaves less room for judgement in banks’ credit provision and can weaken banks’ incentive to take independent responsibility for assessing risk. Standardised requirements can have an undesirable impact in individual cases, limiting some low-risk loans. Credit standards should therefore be adopted in the form of guidelines or a regulation that includes a flexibility quota, a “speed limit”. A speed limit provides banks with room for judgement in their application of the regulation. Banks have used the speed limit to provide loans that do not meet the regulatory requirements.
Finanstilsynet proposes that the regulation be retained with some amendments. Under the proposal, the LTV limit of 60 percent for secondary home mortgages in Oslo is revoked, and banks’ flexibility to extend loans that do not comply with all the requirements in the regulation is set at 8 percent for all parts of the country. Under the current regulation, the speed limit is 8 percent in Oslo and 10 percent in the rest of the country. Finanstilsynet proposes specifying that residential mortgages include mortgages secured on holiday homes. Finanstilsynet also proposes specifying that requirements with regard to debt-servicing capacity, the DTI ratio and principal payments should not under certain conditions apply to reverse mortgages for older homeowners. Finanstilsynet proposes that the new regulation should apply for an indefinite period of time, but states in the consultation document that advice will be provided to the Ministry of Finance on amendments to the regulation, or its repeal, should developments in lending and housing markets so indicate.
Norges Bank supports the proposal to retain the regulation on new residential mortgage loans excluding the specific requirements for Oslo. Norges Bank has no comments on the proposed specifications with regard to loans secured on holiday homes or reverse mortgages for older homeowners.
Norges Bank refers to its consultation response of 4 May 2015, which states “[…] prudent mortgage lending requirements should be regarded as a permanent structural measure and should not be changed frequently.” A permanent structural measure will contribute to predictability and counteract a future slippage in lending practices. The requirements in the regulation should in principle be fixed rules. Adjustments can be made by changing the speed limit.
The DTI limit, introduced in 2017, appears to have had a complementary effect on the other requirements in the regulation and should be retained. The DTI ratio sets a clear limit on debt relative to income and may restrain a further build-up of vulnerabilities in the household sector when house prices are high, interest rates are low and the household sector debt level is high.
In Norges Bank’s opinion, the specific requirements for residential mortgages in Oslo should be removed. The DTI limit has probably had a stronger effect in Oslo than in the rest of the country and its impact is to some extent an alternative to the Oslo-specific requirements. The share of homebuyers with high DTI ratios is larger in Oslo than in the rest of the country, and these buyers will be affected by the DTI limit to a greater extent. There is also reason to believe that the DTI limit may curb borrowing related to purchases of residential property for investment purposes. Regional requirements, in Norges Bank’s view, are not in line with the principle that the regulation should contain fixed rules or that the authorities should not have the ambition of fine-tuning developments in house prices and credit.
The current speed limit of 10 percent should be retained. The introduction of the DTI limit in 2017 restricted banks’ flexibility in providing loans that do not meet other requirements. The housing market correction in 2017 has reduced the risk of an abrupt and more pronounced decline further ahead. Over time, lower house price inflation will curb debt growth and thereby reduce household sector vulnerabilities.
- The main requirements in the current regulation are: 1) a maximum loan-to-value (LTV) ratio of 85 percent, 2) total debt must not exceed five times gross annual income (debt-to-income (DTI) ratio), 3) borrowers’ capacity to service debt in the event of a 5 percentage point increase in interest rates must be tested, 4) principal payments are required for loans with an LTV ratio above 60 percent and 5) an additional requirement for Oslo that LTV ratios for secondary home mortgages must not exceed 60 percent. Up to 10 percent of the total value of a bank’s loans granted per quarter can be loans that do not meet one or more of the requirements, a so-called “speed limit”. For residential mortgage loans in Oslo, the speed limit is 8 percent. Residential mortgage lending requirements were laid down in a regulation for the first time on 1 July 2015. The DTI limit and the requirements specific to Oslo were not included in the first regulation. The principal payment requirement was tightened in 2017. This requirement originally applied to loans with an LTV ratio above 70 percent.
- See Borchgrevink and Næss (2018) “Analyser av effekter av boliglånsforskriften” [Analyses of the impact of the regulation on residential mortgage loans.]. Aktuell kommentar 1/2018. Norges Bank.