Finanstilsynet replied today to the Ministry of Finance’s letter of 23 June 2016 on the question of retaining or, if appropriate, amending the current residential mortgage lending regulations.
After the Ministry of Finance last summer issued regulations setting requirements on new loans secured on residential property, household debt and house prices continued to rise faster than household incomes. 12-month growth in households’ overall debt has continued at a rate of about 6 per cent. Nominal growth in household incomes is concurrently lower than in recent years.
Although there are regional differences in the housing market, house price growth is generally high, and has accelerated in recent months. In August 2016 12-month growth was 9.1 per cent on a national basis.
Increased economic uncertainty, somewhat higher unemployment and significantly lower real income growth must be assumed in isolation to have helped to dampen households’ willingness to borrow and demand for housing. Debt growth and house price growth nonetheless remain high. An important driver of this outturn is the record low interest rate and expectations that it will remain low for a protracted period. In Finanstilsynet’s assessment there is a danger that the high growth in debt and house prices may persist for some time. If it does, it will help to maintain activity in the Norwegian economy but will at the same time heighten the risk of a subsequent abrupt and steep fall in house prices and an economic setback.
The strong growth in house prices and household debt is driven by strong demand. Finanstilsynet emphasises that credit and house price growth resulting from strong demand is difficult to halt using measures targeting the supply of credit. Such measures may however help to dampen credit growth and thereby safeguard long-term considerations for the individual borrower, the individual bank and the financial system.
Finanstilsynet’s residential mortgage lending survey in autumn 2015, the banks’ interim reports and surveys by Norges Bank and the IMF indicate that banks’ lending practices have tightened somewhat after the new regulations were introduced. The growth in lending may thus have been lower than it would have been in the absence of the new regulations. That said, it is in Finanstilsynet’s view difficult to quantify with a reasonable degree of certainty the effect that the regulations in isolation may have had on banks’ lending growth.
Direct regulation of lending practices is an intrusive policy instrument and must be applied in proportion to the risk of financial instability. In light of the recent developments in the debt and housing market, Finanstilsynet considers there is now cause to tighten the regulatory provisions. The regime can be eased, in the event lifted, in the event of a subsequent turnaround in the debt and housing market.
Finanstilsynet has considered possible amendments to the regulations on the basis that a significant, but not dramatic, tightening of lending practices should be achieved. Finanstilsynet proposes the following measures:
- Removal of the banks’ opportunity to waive the regulations’ requirements on debt servicing ability, loan-to-value ratio and amortisation of debt.
- The current requirement on the borrower’s debt-servicing ability to be supplemented by a provision limiting the borrower’s overall loan to five times gross annual income.
- The maximum loan-to-value ratio for home equity credit lines to be lowered from 70 per cent to 60 per cent.
- The requirement on amortisation of repayment loans to apply to all loans with a loan-to-value ratio above 60 per cent, compared with 70 per cent under the current regulations. This is a natural consequence of the proposal to lower the loan-to-value ratio for home equity credit lines.
The Ministry of Finance attached much importance to the banks’ opportunity to exercise judgement when the ministry established a flexibility quota of 10 per cent in the current regulations. The 10 per cent limit must be viewed as substantial in light of the development in debt and house prices. Although the opportunity to waive the regulatory requirements should in Finanstilsynet’s assessment be removed, lowering the 10 per cent limit may also be an important contribution to tighter lending practices. Should the Ministry of Finance wish to retain the provision on flexibility in the regulations, Finanstilsynet proposes that the ministry lowers the limit from 10 per cent to a maximum of 4 per cent.
Finanstilsynet has, in light of regional differences in the housing market, considered a geographical differentiation of the maximum loan-to-value ratio for residential mortgage loans in the respective regions. Finanstilsynet does not recommend such differentiation.
Finanstilsynet proposes that the tightening measures be put into effect as from 1 January 2017. Finanstilsynet emphasises that the regulations should be lifted, in the event amended, when this can be justified by market conditions.
Letter to the Ministry of Finance is included in the Norwegian press release.