Consultation response – amendments to loan regulations
Norges Bank's letter of 10 November 2020 to the Ministry of Finance.
Norges Bank refers to the consultation letter of 29 September 2020 from the Ministry of Finance requesting comments on Finanstilsynet’s (Financial Supervisory Authority of Norway) proposal for the regulations on financial institutions’ credit standards to remain in force, albeit with some amendments. Today’s residential mortgage loan regulation and consumer credit regulation are both in force until 31 December 2020.
Finanstilsynet proposes that the requirements concerning credit standards for residential mortgage loans and consumer credit should be consolidated in one regulation, that the regulation should remain in force indefinitely and that it should be expanded to include credit secured on collateral other than housing. Finanstilsynet also proposes reducing the maximum debt-to-income (DTI) ratio from 5 to 4.5 times annual income. In addition, Finanstilsynet proposes setting banks’ flexibility quota for residential mortgage loans, ie the percentage of these loans banks can extend that do not meet one or more of the regulatory requirements, at 5 percent across Norway. The quota under the current residential mortgage loan regulation is 10 percent, except in Oslo, where the quota is 8 percent. Finanstilsynet also proposes revoking the loan-to-value (LTV) limit of 60 percent for secondary home mortgages in Oslo. For loans other than residential mortgage loans, Finanstilsynet proposes that there should be no flexibility quota. The current consumer credit regulation prescribes a flexibility quota of 5 percent.
Norges Bank supports the proposal for these loan regulations to remain in force and to be consolidated in one regulation. Norges Bank refers to its letter to Finanstilsynet of 16 September 2020 containing background data and an assessment of the residential mortgage loan regulation and the consumer credit regulation. In its letter, Norges Bank writes that developments do not warrant amendments to the credit standard requirements for residential mortgage loans and consumer credit.
Credit market regulation must strike a balance between the objective of credit market efficiency and the objective of mitigating the build-up of risk in the financial system. Regulation of credit standards can dampen the build-up of vulnerabilities in the household sector. On the other hand, credit standard regulation intervenes in banks’ exercise of judgement. Standardised requirements can have an unfavourable impact in some cases, weaken banks’ incentive to assume independent responsibility for assessing risk and have a normative effect. Credit standard regulation can also lead to the emergence of new sources of credit or forms of credit that are not subject to regulation.
In Norges Bank’s view, the residential mortgage loan regulation has worked well and takes these trade-offs into account in an appropriate manner. The regulation defines clear limits for prudent lending practices and has had the effect of limiting banks’ lending to vulnerable households. At the same time, the flexibility quotas allow banks to extend residential mortgage loans that are in breach of the requirements based on a customer-specific assessment. Such quotas also underpin banks’ own responsibility for maintaining prudent lending practices.
The consumer credit regulation also seems to have worked well, restricting lending to vulnerable households. Although consumer credit makes up a limited share of total household debt, it can reduce households’ capacity to service other debt. In Norges Bank’s view, the flexibility quota for consumer credit should be lower than for residential mortgage loans. Defaults on consumer loans can spill over to other creditors through foreclosures and seizure of other collateral. The basis of consumer credit regulation is the objective of financial stability. The regulatory requirements also contribute to consumer protection, which may imply that the flexibility quota should be set at zero. In its letter to Finanstilsynet of 16 September, Norges Bank wrote that removing the flexibility quota for consumer loans should be considered, in line with Norges Bank’s consultation response of 29 October 2018 on the consumer credit regulation. Similarly, Norges Bank holds the view that any flexibility quotas for loans secured on collateral other than housing should be low, or zero as proposed by Finanstilsynet.
Norges Bank supports Finanstilsynet’s proposal that the requirements should be consolidated in one regulation and that the regulation of lending to the retail market should be expanded to include loans secured on collateral other than housing. This could help to prevent borrowers from circumventing the rules. In Norges Bank’s view, the credit registers should be expanded to include residential mortgage loans. Other types of credit that will come under the consolidated loan regulation should also be included in the credit registers based on an assessment of the scale of lending and the costs of inclusion in the register.
Norges Bank supports the proposal for the consolidated loan regulation to remain in force indefinitely. In its letter to Finanstilsynet of 16 September 2020, Norges Bank wrote that the regulatory requirements should be assessed at regular, albeit not frequent, intervals, for example every three years. The Bank can support Finanstilsynet’s proposal of every other year. The authorities should not have the ambition of fine-tuning credit and house price developments. In special cases, the flexibility quotas can be adjusted at times other than the intervals decided on for assessing the requirements in the regulation. During the severe contraction in the Norwegian economy this spring, the flexibility quotas were temporarily expanded. If vulnerabilities in the household sector increase markedly as a result of rapid debt growth and house price inflation, tightening the flexibility quotas should be a possibility.
In Norges Bank’s view, the two flexibility quotas of 8 percent for Oslo and 10 percent for the rest of Norway should continue to apply. Finanstilsynet proposes a general quota of 5 percent across Norway. The flexibility quota for residential mortgage loans in Oslo may have dampened debt growth in Oslo. Setting a separate flexibility quota for Oslo may prevent banks from using a relatively larger share of the national quota in Oslo. Utilisation of the increased flexibility quotas in the second and third quarters of 2020 suggests that the general quotas can sometimes constrain bank lending. The share of loans in breach of the requirements increased to higher levels in Oslo than in the rest of the country in this period.
In Norges Bank’s view, the equity requirement for secondary home mortgages in Oslo should continue to apply and could to advantage be expanded to apply to the whole country. Requiring a high proportion of borrower equity for secondary home mortgages could reduce the risk of investors selling secondary homes in downturns and thus amplifying a fall in prices. This requirement has likely reduced buy-to-let purchases in Oslo and may have dampened price pressures. This suggests that the requirement should also apply in other areas that may be attractive to investors in the secondary home market, for example near Oslo. In areas where housing market pressures are more subdued, the introduction of the requirement will likely have modest consequences.
Finanstilsynet’s proposal to tighten the limits on the maximum DTI ratio and flexibility quotas in the residential mortgage loan regulation is similar to that proposed by Finanstilsynet in autumn 2019. In its response to that consultation, Norges Bank wrote that the proposal as a whole would constitute a substantial tightening of the requirements in the regulation. Finanstilsynet’s residential mortgage lending survey for 2019 shows that about 20 percent of new repayment mortgages were issued at DTI ratios between 4.5 and 5. The survey also shows that the average DTI ratio is higher among younger age groups. Tax return data show that the share of households with DTIs between 4.5 and 5 is highest for low- and middle-income households. Reducing the DTI limit from 5 to 4.5 could mitigate the build-up of household sector vulnerabilities. Such a tightening would at the same time restrict credit supply for many households. In Norges Bank’s view, the current residential mortgage loan regulation takes this trade-off into account in an appropriate manner and the DTI limit should not be changed at this time.
 The letter is part of the consultation document proposing a new, consolidated regulation.
 Norges Bank's consultation response - Assessment of the regulation on requirements for new residential mortgage loans. Letter of 14 October 2019 to the Ministry of Finance.