Financial stability - risky, safe, or just
right?
A speech delivered to UBS Australasia Conference 2018 Sydney, Australia
By Geoff Bascand, Deputy Governor and Head of Financial Stability
13 November 2018
2 The Terrace, PO Box 2498, Wellington 6140, New Zealand
Telephone 64 4 472 2029 Online at www.rbnz.govt.nz
Introduction1
Thank you for the opportunity to speak with you.
For the first time in 30 years, New Zealand is fundamentally reviewing the role and powers of
the Reserve Bank as they relate to financial stability.
The Government's review is not in response to a crisis. The fact that it's 10 years since the
Global Financial Crisis (GFC), 20 years since the Asian financial crisis, and 30 years since
New Zealand's share-market crash and our own financial crisis is surely just a coincidence!
The aim of the review is to test whether our financial policy framework is fit for purpose and
whether it needs modernising. It makes sense to test that the regime is well founded for the
next 30 years. The financial system has grown in size, complexity and interconnectedness.
It continues to change with institutional, technological and financial innovations generating
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new products, services, rewards and risks.
The Reserve Bank, or Te Pūtea Matua, is the big tree, Tāne Mahuta,
that sits at the centre
of New Zealand's financial ecosystem.
Our challenge is to ensure that the various elements of this financial ecosystem work
together to deliver a sound and efficient financial system for all New Zealanders. And that we
don't stifle desirable innovation and minimise unnecessary friction
deliver soundness,
between borrowers, savers and investors. A thriving financial system provides huge benefits:
enabling payments, financing investment, facilitating borrowing, and yielding returns to
savers. When it falters or freezes up, costs are large and pain is felt throughout society.
In common with most central banks we are responsible for the stability of our financial
system. Our role is to manage risks to New Zealand's stability and to mitigate the
consequences if they are realised. Today I am going to focus on our risk tolerance and how
we determine it.
I want to address two main topics:

First, why financial stability matters and what threatens it?

Second, and most importantly, how do we pursue our financial stability objective? This
key point can be thought of in terms of three questions:
o what is our risk tolerance; how safe do we think the financial system should be?;
o how do we strike the right balance between soundness and efficiency?; and
o how do we adapt as risks to financial stability emerge?
Why does financial stability matter for New Zealanders?
First, why does financial stability matter? The answer is that bank crises are frequent and
bank crises hurt.
Since the mid-1970s there have been over 140 banking crises2 around the world. And they
have had large costs for the affected economies and societies.
1
I am very grateful to Piers Ovenden for considerable assistance in the preparation of this speech, along
with valuable comments from other Reserve Bank colleagues.
2
Laeven and Valencia define a banking crisis as systemic if two conditions are met: (1) significant signs of
financial distress in the banking system (as indicated by significant bank runs, losses in the banking
On average a bank crisis costs a country 23% of its GDP, while public debt increases by
around 12 percent.3 The amounts are higher for advanced economies. And as a rule, the
deeper the banking system, the larger the disruption and the higher the costs.4 Recessions
associated with financial crises are deeper than recessions that are not.
The consequences in terms of employment are also severe. After the GFC, Ireland's
unemployment rate rose from 4.6 percent in 2006 to 15 per cent in 2012,5 with youth
unemployment even higher. In addition there can be broad welfare consequences in terms
of declining physical and mental health, regardless of whether an individual is directly
affected by job, income or housing loss.6
The impact of a crisis on the wider economy is also long lasting. Recovery can take a
decade or more and is halting in nature.7
We have seen in the aftermath of the GFC, monetary and fiscal policy responses -bail-outs
-
and quantitative easing have important implications for transfers of wealth between the
private and public sector, social inequality and inter-generational welfare.
-
So financial stability matters and not just to the depositors, creditors and counter-parties of
an affected institution. It matters to the economy and society as a whole.
This isn't something that we can count on observing from the
global sidelines. New Zealand
is clearly not immune to crises.
In the late 1980s the Bank of New Zealand had to be recapitalised twice by its government
and private sector shareholders. More recently, between May 2006 and the end of 2012, we
witnessed the collapse of finance companies.
As the GFC unfolded the New Zealand government introduced a guarantee scheme that
covered up to $133 billion in deposits and investor funds. By the time the scheme was
withdrawn, the Crown had paid out approximately $2 billion to depositors for losses from
failed entities.8
system, and/or bank liquidations); and (2) significant banking policy intervention measures in response
to significant losses in the banking system. See 'Systemic Banking Crises Database: An Update', IMF
Working Paper, by Laeven and Valencia, 2012.
3
Output losses are calculated as deviations of actual GDP from its trend and increases in public debt is
measured as the change in the public debt-to-GDP ratio over the four year period beginning with the
crisis. See 'Systemic Banking Crises Database: An Update', IMF Working Paper, by Laeven and Valencia,
2012.
4
The costs of banking crises can vary markedly. The gross fiscal cost of the crisis in Iceland - a small,
open and financially integrated country like New Zealand - mainly in terms of bank recapitalisations and
asset purchases, was 44% of GDP. In Ireland the pre-crisis boom in construction and subsequent collapse
of the local banking system, resulted in a government bail-out amounting to approximately 40% of GDP.
Iceland and Ireland also feature among the ten costliest banking crises in terms of overall increases in
public debt - at more than 70% of GDP within four years. See 'Systemic Banking Crises Database: An
Update', by Laeven and Valencia, 2012.
5
See 'Seasonally Adjusted Standardised Unemployment Rates', Central Statistics Office at
https://www.cso.ie/en/statistics/labourmarket/principalstatistics/seasonallyadjustedstandardisedune
mploymentratessur/
6
See 'Health Impacts of the Great Recession: A Critical Review', by Margerison-Zilko, et al., 2017.
7
World Economic Outlook, IMF, October 2018; and 'Recovery from Financial Crises: Evidence from 100
Episodes' by Reinhart and Rogoff, American Economic Review, 2014.
8
Office of the Auditor-General, 2011.
Serious incidents (that could have led to a crisis) are more common than people realise.
Over the years various institutions have suffered significant losses and either had to raise
additional funds from the market or be supported by the government.
The scale and impact of these events is much wider and greater than the immediate costs to
the affected institution. When Development Finance Corporation (DFC) failed in 1989, it was
the 7th largest financial institution in NZ, was not a settlement bank and had only a small
amount of retail funding. Yet it turned into a major event that knocked confidence in the
financial system and affected views of New Zealand held by international investors for some
time.
Ultimately the risk of a crisis in New Zealand is determined by whether the many risks in the
global ether are relevant to us. Snake bites are unpleasant but not very pertinent to most
New Zealanders.
New Zealand's financial ecosystem
So what does look like and what are its vulnerabilities?
Figure 1
Size of financial sectors in New Zealand
New Zealand's banking system is large relative to the size of our economy
and our financial
system, with banking system assets worth $527 billion, or 186 percent of GDP (figure 1).
It reaches almost all New Zealanders, with over 99 percent of us having bank accounts.
An important feature is that it is highly concentrated: of the 26 registered banks in New
- -
Zealand, four banks all Australian owned account for more than 85 percent of bank
assets.
From one perspective we are well placed, compared to say, the Eurozone, where large
banks operate across national boundaries as branches, under a single currency.
We have an effective home-host relationship with APRA and our four largest banks are all
locally incorporated. Their size and dominance of our banking sector is an important
consideration for our regulatory approach: they must be able to stand on their own in New
Zealand.
Other parts of the ecosystem include insurers, payment and settlement systems, capital
markets and non-bank lending institutions. Although these sectors are small in comparison
to the banking sector, they play an important role in the financial system: ensuring that
companies can operate with confidence and manage their risks, facilitating smooth and
efficient payments within the economy, and providing capital to particular market segments.9
We have seen risks emerge from the "shadow banking" sector before and remain alert to
developments in the wider financial sector.
What threatens our financial system?
New Zealand's financial system has two main vulnerabilities: our high levels of indebtedness
(in the household and dairy sectors) and our reliance on foreign sources of funding.
Given the nature of the New Zealand economy and our financial system these risks are not
going away. Our next assessment of them will be detailed in the Financial Stability Report to
be published 28 November.
High levels and concentrations of debt
- -
The majority of bank lending is to the household sector at 58 percent and secured
against housing assets. Household sector indebtedness represents the New Zealand
financial system's single largest vulnerability.
9
The insurance sector has around $70 billion in total assets, equivalent to 25 percent of GDP. The
unlicensed sector is made up of the government-owned Accident Compensation Corporation (ACC), the
Earthquake Commission (EQC) and the Southern Response Earthquake Services - a government owned
insurer resulting from the government bail-out of AMI following the Canterbury earthquakes - as well as
some small private insurers.
NZX's market capitalisation is around $135 billion, while the total value of the domestic bond market is
around $131 billion (excluding government debt). The fund management sector has around $125 billion
of assets (both domestic and offshore) under management.
The Non-Bank Lending Institutions (NBLI) sector provides around a third of consumer lending to New
Zealanders but it remains small relative to the rest of the financial system. Mortgage lending from NBLI is
around 3 percent of the total across the financial system. Of the NBLI, 25 are licensed Non-Bank Deposit
Takers (NBDTs) - financial firms that accept deposits but are not registered banks - with total assets
worth $2.5 billion. Other lenders that do not take deposits, and therefore are neither banks nor NBDTs,
have total assets of $9.7 billion.
The Reserve Bank operates the Exchange Settlement Account System (ESAS), which settles all interbank
payments, and NZClear, which settles trades of securities.
Two thirds of systemic banking crises around the world have been preceded by a housing
boom and bust.10 Highly indebted households are vulnerable to shocks, such as higher
interest rates or unemployment, that reduce their debt servicing capacity. This can lead to
households cutting their consumption, selling their house or, if the shock is severe enough,
defaulting on their loans.
Household indebtedness has increased dramatically in New Zealand in the last 30 years. In
1988, the average household owed around $16,000 in debt and had an income of around
-
$35,000 a debt-to-income ratio of 46 percent. By the end of 2017, this ratio had risen to
168 percent, following a ten-fold increase in average household debt to nearly $160,000,
while average incomes had only slightly less than tripled to $95,000.
Credit extended to households in New Zealand as a percentage of GDP has risen from 27.9
- -
percent in 1990 relatively low compared to other countries to 92.2 percent (figure 2).
Figure 2
Credit to Households as a percentage of GDP
% %
140 140
Australia
Canada
120 120
United Kingdom
Japan
100 100
New Zealand
Sweden
United States
80 80
60 60
40 40
20 20
0 0
1964 1971 1978 1985 1992 1999 2006 2013
Source: Bank for International Settlements.
Note: Credit to households and NPISHs from all sectors at market value.
Of course, systemic crises can emanate from different sectors. The level and concentration
of dairy sector debt has increased significantly in recently decades, to become the next
largest share of bank lending after housing. And a relatively large proportion of bank losses
in past financial crises are estimated to have come from loans to the commercial property
10
See 'How to deal with real estate booms: Lessons from country experiences' by Crowe, Dell'Ariccia,
Denis, Rabanal, IMF Working Paper, 2011, referred to in 'Financial stability risks from housing market
cycles' by Thornley, RBNZ Bulletin, July 2016.
sector.11 Problems in these sectors would not threaten financial stability on their own,12 but
could significantly amplify losses to the banking system during a severe macroeconomic
downturn.
Foreign funding
New Zealand's other main vulnerability is foreign funding. We rely on the willingness of
foreigners to lend to us, and to continue to lend to us, in order to fund our homes and our
businesses.
New Zealand's net foreign liabilities -
the difference between what we owe the rest of the
-
world (our liabilities) and what the rest of the world owes us (our assets) are high relative
to most other developed economies.
While most of our offshore funding is hedged we are vulnerable to disruptions in global
financial markets.
An increase in interest rates overseas can rapidly flow through to retail rates in New Zealand
if bank funding is rolled over at higher prices. These fluctuations in funding costs are
illustrated in figure 3. Perhaps more worrying is the risk of a market seizure where rollover is
simply not feasible in the necessary timeframe, and credit has to be severely curtailed to
address liquidity constraints.
Figure 3
bps Index
Offshore funding
500 100
costs and market
Offshore funding spread
uncertainty
VIX (RHS)
400 80
300 60
200 40
100 20
0 0
2006 2008 2010 2012 2014 2016 2018
Source: Bloomberg.
Note: The offshore funding spread is the NZD cost of one of the largest
four banks issuing a 5-year bond in the US relative to the 5-year NZ
swap rate. The VIX index is an indicator of the market's expectation of
the 30-day volatility in the S&P 500 equity index.
-
Banks have actively reduced their reliance on offshore funding since the GFC particularly
-
at short maturities in order to reduce risk and respond to regulatory changes, such as our
liquidity policy.13 However our reliance on foreign funding remains a significant vulnerability
and is not going to go away while New Zealand remains a net borrower from overseas.
11
'Financial stability risks from housing market cycles', Thornley, BRBNZ Bulletin, July 2016.
12
Lending to the agriculture sector in New Zealand accounts for around 14 percent of total lending, of
which the dairy sector accounts about for two-thirds. Loans to the commercial property sector comprise
8 percent of total bank lending in New Zealand.
13
The Reserve Bank introduced a Core Funding Ratio requirement for banks in 2010 that required them
to hold more long-term foreign funding plus retail deposits, a ratio that was then increased in 2013.
Soundness and efficiency; finding an appropriate standard of resilience for the
financial system
Given the structure of our financial system, its vulnerabilities and risks, how safe should we
aim to make it? If Goldilocks visited our ecosystem, what would be too risky, too safe and
just right?
Our financial policy objective is to 'promote the maintenance of a sound and efficient
financial system'.
The soundness goal means promoting the resilience of the financial system as a whole and
intervening to mitigate risks to it.
The efficiency goal means different things in different contexts: we minimise compliance
costs; we support innovation and operate a regime that is open to new entrants; we avoid
creating unnecessary frictions in the supply of credit to the economy; and we ensure that
financial resources are allocated in a productive (and not harmful) way to maximise long
term economic growth.
A key goal of Phase 2 of the Government's review is to clarify the scope and meaning of
'sound' and 'efficient'; and whether these are still the right
terms.
Taken together, soundness and efficiency are akin to the financial stability mandates of other
central banks. They empower and obligate the Reserve Bank to ensure the financial system
works effectively in support of the prosperity and wellbeing of New Zealanders and
contribute to a productive and sustainable economy. Along with our price stability and
maximum sustainable employment objectives, they empower the Bank to stabilise the
in terms of society's
financial cycle and to mitigate the booms and busts that are inefficient
economic welfare.
The costs of banking crises mentioned earlier make it clear that financial stability is
important; prevention is better than cure and we should err on the side of caution.
Our focus on achieving financial stability has been, and remains, primarily systemic rather
than on individual institutions. We do not run a zero-failure regime (i.e. financial institutions
can fail), and we expect all participants to do their part.
We pursue our financial stability goal by using the levers and tools that are available to us.
Some of these are baseline standards, others are relevant as risks emerge or eventuate
(figure 4). The key is that we don't think of each one in isolation
and calibrate each one
accordingly.
Figure 4
RBNZ tools Self Mkt Reg Permanent Time varying Event
Institutional rules Governance
Risk management
Attestations
Licensing & NZ incorporation
Outsourcing
Transparency Disclosure
Financial requirements Minimum capital
requirements/solvency standards
Conservation & counter cyclical
buffers
Sectoral Capital Requirements
Core Funding Ratio
Loan to value restrictions
Funding & liquidity Liquidity standards
Collateral standards / RMOs
LoLR
Foreign exchange intervention
Infrastructure FMI rules and powers
Monitoring Financial Stability Report
Stress testing
Supervision & engagement
Thematic reviews
Enforcement Investigations
Directions
Monetary policy OCR
Crisis management OBR
Statutory management
Our three pillar approach to supervision emphasises self and market discipline, alongside
regulatory discipline. We place a strong emphasis on sound corporate governance, ensuring
(where possible) that individual institutions have incentives to manage their own risks; and
on disclosure14 enabling investors to monitor risks to financial institutions.
The risk of market failure means we must also have a robust regulatory pillar. Given the
externalities at play in the financial system, the systemic costs of financial instability will not
be addressed through self and market discipline alone.
When an individual bank chooses to reduce its resilience, it will only face the private cost of
its decision. The social cost will include, for example, the bank aggravating a boom-bust
cycle by unduly relaxing lending standards. The perverse incentives are compounded if it is
difficult for market participants to detect an increase in risk-taking (asymmetric information).
We agree with the IMF's FSAP report that the regulatory pillar should be stronger, and that
we should adopt a more intensive approach to supervision.
We are strengthening our supervision of individual institutions. We are making more frequent
use of thematic reviews on areas of heightened risk, and we continue to strengthen our
collaboration with APRA. We recently released our joint report with the FMA on Bank
Conduct and Culture.
As the IMF pointed out, increasing supervisory resources for all financial sectors is key to
boosting effectiveness and responsiveness. We have sought additional resourcing to do this
-
a point that will be considered by the Government as part of Phase 2 of its review.
Within this framework the key question is how we establish a rigorous and fair baseline of
resilience for prudential regulation. Again it's the goldilocks question, what is
too risky, too
safe, and just right? In the end it is a judgement based on experience, analysis and
consultation.
For example, we require non-life insurers to hold sufficient capital reserves or reinsurance to
cover liabilities for a 1 in 1,000 year catastrophe event. We have set the bar high relative to
global insurance standards due to New Zealand's vulnerability to natural disasters and to
promote public confidence in our insurers.15
Capital review
In the case of banks we are currently reviewing the capital adequacy framework.
The aim of the capital review is to identify the most appropriate framework for setting bank
- -
capital requirements the amount of capital banks have to absorb losses taking into
account both how our current framework has operated and international developments.
There are several guiding principles. One is that capital requirements should be
conservative, reflecting the importance to New Zealand of sound credit ratings, given our
reliance on offshore borrowing and susceptibility to international shocks. Another is that
capital requirements should be set in relation to the risk of bank exposures. This is
particularly important for New Zealand, where banking sector assets account for the majority
of total financial system assets and are concentrated in housing and agricultural lending.
14
Earlier this year the Reserve Bank launched the Bank Financial Strength Dashboard. It allows financial
information to be compared across banks. The aim is for the Dashboard to improve bank disclosure and
public awareness and to make it easier for banks to benchmark themselves against each other.
15
On the other hand, our monitoring and oversight of insurance company risk-taking and compliance is
limited. We have only 10 supervisors and actuaries overseeing around 90 insurance companies.
Our aim in setting minimum capital ratios and buffers is to ensure that the banking sector
can absorb shocks, maintain market confidence, and continue to supply credit during times
of economic stress. In other words, we take a systemic and through-the-cycle view of
prudential regulation. This reduces the risk of spillover from the financial sector to the real
economy.
Soundness is not easily translated into a single, quantifiable benchmark against which
performance can be monitored. The academic literature and various countries' prudential
reforms since the GFC suggest there is a wide range of views on the optimal quantity and
quality of capital for a banking system. Indeed, the literature generally suggests that
'optimal' capital is not only higher than regulatory minimums, but can also span quite a wide
range. The literature is therefore helpful in pointing to the direction that regulatory capital
should travel, but not the destination.
We are naturally cautious in how we think about risk to the banking sector. We operate in the
uncertain: the origin of the next crisis is unknown. And as alluded to earlier, a banking crisis
would have significant costs for ordinary New Zealanders that would persist for years, in
terms of economic output, public debt, employment and welfare.
There is a good argument that there are soundness and efficiency gains to be made by
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requiring banks to hold more capital within reason. More capital would help deliver both
greater certainty, and higher expected output (before and after a crisis).
This is illustrated by figure 5, where the level of financial stability is measured on the X axis
and the expected output is measured on the Y axis.
At some point more certainty comes at a cost, though this may be justifiable if we desire
greater certainty. However based on the literature and the views of other regulators it would
seem that we are a long way from that trade off.
-
Some will argue that certainty comes at a price that share capital is a more expensive form
of funding than debt. There is a debate as to how high that price really is. And we need to
weigh those private costs against the social costs of a crisis.
Figure 5
A framework for thinking about our policy goal
Output
Financial Stability
Low High
The question remains, how much certainty do we want, how risky do we want our financial
system to be in the long-term? Goldilocks returns with the same question what level of
financial stability is too risky, too safe, or just right?
To answer this we need to think about our risk tolerance for crises.
Stress tests
One input into informing the Reserve Bank's risk tolerance is stress testing.
We ask banks to consider what would happen in the event of a severe but plausible
hypothetical scenario, with macro-economic outcomes that are broadly similar to the
financial crises discussed earlier.16
By quantifying the impact of this scenario on bank balance sheets and profitability, the stress
tests help us to understand whether the amount of capital banks hold is enough to absorb
losses under that scenario and to better understand risks to financial stability. They are also
used to support banks in developing their own risk management practices.
Stress tests are an important lens on both the capital adequacy of banks and on our own risk
tolerance. They can help us to explain to the public the sorts of tail events that we worry
about, and assist participants and the public in understanding the resilience of individual
institutions, and the financial system as a whole, to those risks.
That said, there is no direct link between stress tests and our banks' capital requirements.
Interpreting their implications for system resilience requires many judgements, including on
the levels of capital necessary for individual banks to maintain market confidence.
Stress tests can't cover all
risks, or the right risks happening at the same time to all banks. It
is just one scenario. And banks know how the stress scenario will play out in advance, which
makes it more contained than it would be in practice.
The GFC taught us that a synchronised global downturn can happen very quickly and what
was thought truly exceptional (ie the Great Depression) might not be so improbable. It is
difficult to capture the real-world complexities of a financial crisis within formal modelling
approaches used for stress testing.
Liquidity
The GFC also demonstrated that the dangers to our banks may not lie just in the quality of
their asset portfolios but in their ability to roll-over their funding, and at what cost. In other
words liquidity can be the catalyst for financial stability risk.
Our liquidity policy requires banks to maintain specified ratios of expected net cash inflow or
outflow. It is intended to reduce the likelihood that an individual bank needs to call on us as
the lender of last resort, and ultimately reduce the risk of a bank failure.
Our minimum standards for liquidity risk also reflect the highly concentrated nature of our
banking system and its reliance on foreign funding. We intend to review our liquidity
standards next year, in light of new Basel Committee liquidity requirements.
16
To date these exercises have centred on the four largest New Zealand banks - reflecting that they
account for around 90% of banking system assets. The scenario we used for the stress test in 2017 set a
high bar. It asked banks to consider how they would fare if there was a downturn in the Chinese economy,
collapse in demand for commodity exports, a rapid increase in unemployment, a 35% fall in house prices,
a two notch downgrade in their credit rating downgrade, a spike in funding costs, and a significant
misconduct event related to residential mortgages. The results of the 2017 stress test suggest that the
four main New Zealand banks could absorb material losses in a downturn while remaining solvent.
Adapting to emerging risks
Establishing a baseline standard of resilience is not a set-and-forget exercise. It needs to be
-
re-visited from time to time to ensure it is still appropriate as we are doing with our capital
review and as we will with our liquidity review next year.
-
We also need to remain aware of changes in risks across the financial system for example,
when intense competition leads to dilution in lending standards, or irrational exuberance
leads to credit and asset booms. We need a macro view of emerging risks that reinforces the
baseline prudential settings.
Credit-fuelled housing booms are a good example of this elevation of risk. They have been
common in the lead-up to financial crises in advanced economies in recent decades.17
The purpose of macro-prudential policy is to lean against these time-varying risks. Our
objective is to address emerging systemic risks by increasing the resilience of the domestic
financial system and countering instability that arises from credit, asset price or liquidity
shocks.
As agreed with the Minister of Finance in the 2013 Memorandum of Understanding, we have
four tools to implement macro-prudential policy: the countercyclical capital buffer, sectoral
capital requirements, the core funding ratio and loan-to-value restrictions (LVRs) (see figure
4).
The first three tools increase the resilience of banks directly. Mortgage lending policies like
- -
LVRs and Debt-to-Income (DTI) ratios, which are yet to be included in our toolkit limit the
amount of lending banks can do within defined parameters in order to promote soundness.
As for baseline standards, the use of macro-prudential tools may require trade-offs between
soundness and efficiency,18 between financial stability and output. And as for the baseline
standards we operate in conditions of considerable uncertainty. During an economic boom, it
is often hard to tell whether easing lending standards or rapid credit growth is justified by
strong economic fundamentals and whether swings in capital allocation are efficient or not.
We aim to deploy and calibrate the right macro-prudential tool to address both the perceived
risk and the efficiency implications, whether by changes to banks' capital requirements or
influencing lending behaviour.
To date we have only deployed the LVR tool, in response to rapid house price growth and
-
the sharp increase in the provision of high LVR loans that is loans with relatively small
deposits. The Reserve Bank's speed limit on high-LVR loans has been an important mitigant
to the significant increase in financial system risks associated with mortgage loans over the
past five years. By improving the resilience of household balance sheets, the policy is
expected to lower the numbers of households that are forced to sell their house or
significantly reduce expenditure in a severe downturn.
17
In the five years prior to the start of the GFC, house prices increased about 60 percent in the UK and 40
percent in the US. In the following five years, prices fell about 15 percent in the UK and 36 percent in the
US.
18
Measures may improve both efficiency and stability. In the case of 'irrational over-investment',
externality costs exist with consumers and investors taking insufficient account of costs imposed on
others from the increased risks of failure or recession, while capital misallocation also occurs. In this case
stability and efficiency would both be increased through macro-prudential measures.
Our risk tolerance for the recent housing and credit boom is implied by our calibration of the
LVR restrictions.19 We keep these settings under review and will publish our next
assessment of them in the upcoming FSR. The question we are assessing is whether the
same restrictions are needed in the current environment where debt levels remain high but
are not deteriorating, now that bank lending standards have tightened significantly and rapid
growth in credit and house prices have stabilised. If these conditions continue, we expect to
gradually ease the policy in coming years.
The other macro-prudential tools also have an important role to pla