Last month I wrote about the Reserve Bank releasing a consultation document on their proposal to separately classify residential rental property loans from owner occupied residential loans. The NZPIF have now examined the consultation document and made a submission on the Reserve Banks proposal.
The Bank's purpose for separately classifying rental property loans is so that banks are forced to apply higher capital requirements to these loans, potentially increasing the banks costs.
The Bank's rationale for doing this is that rental property loans are more likely to default during an economic downturn. They say that banks need to hold more capital against rental property loans to improve the financial stability of the banking system in the event of a severe economic downturn.
The Bank supports their position by quoting two studies into the Irish housing market, which crashed severely in 2007.
The Irish economy expanded rapidly from the mid 90's to 2007, due to a heavy infrastructure investment by the EU and drastically reduced income tax rates. This resulted in higher net incomes and an influx of migrants. Based on this, Ireland embarked on a massive house building campaign that far outstripped demand. Following the Global Financial Crisis, the economy went into serious recession and large new housing estates were left empty with no buyers. House prices plummeted.
However the situation in Ireland was extreme, with a complex series of factors that are unlikely to ever occur in New Zealand. In the NZPIF submission to the Reserve Bank's consultation document, we point out that the research papers that the Reserve Bank use to make their case also state that "comparison between UK and Irish lending show loans are up to 5 times more likely to default in Ireland". The paper also states that "this reflects the seismic growth in the Irish mortgage market and relaxing of credit standards through the housing price boom (that) puts the credit quality of the Irish book into context".
The Reserve Bank states that "evidence from Ireland suggests that loss rates for investors were nearly twice as high as for owner-occupiers". However we have pointed out that to make this claim, the Bank has used estimates made in 2011 of expected losses in the years 2011 to 2013 rather than research of actual losses.
We have pointed out in our submission that the research papers also say that the Irish investment property loans had lower levels of arrears than owner occupied loans. The research paper says that this demonstrates that banks are more likely to default rental property loans than owner occupied loans. This is the reason rental properties have higher default rates rather than being inherently riskier than owner occupied loans.
The NZPIF has found research from the United State Federal Reserve that says while investment property defaults during the USA housing downturn were higher than owner occupied loans, the difference was minimal.
For all these reasons, the NZPIF submission is that there is inadequate evidence that rental property loans are a higher risk than owner occupier loans. This means that there isn't a good factual basis to increase capital requirements for these loans.
The NZPIF submission recommends that the Reserve Bank does not proceed with plans to either classify rental property loans or require banks to hold higher capital reserves for such loans. This can only have the potential for costs to increase, lower investment in rental property leading to lower supply and rising rental prices.