for the lender. a restriction on the volume of high lvr loans should reduce the inherent risk in banks ’ mortgage portfolios as well as reducing the overall supply of credit to the housing market. the international evidence suggests that a prevalence of high lvr lending can accentuate loan losses and worsen economic disruption when inflated house prices correct abruptly. two examples are the united states and ireland. while lending practices in these countries were far more extreme than we have seen in new zealand, their experiences are instructive. in both countries, house price appreciation was fuelled by competition between lenders, and falling lending standards. by 2006, 20 percent of new mortgage lending in the united states was sub - prime, often with minimal credit checks and very high lvrs. similarly in ireland, lending was often occurring at lvrs over 100 percent. annualised house price growth peaked at 16 per cent and 15 per cent in the us and ireland in the lead up to the gfc before falling sharply. the subsequent sharp downturns gave rise to considerable financial distress in both countries, with high lvr borrowers particularly hard hit. at the bottom of the us housing market in 2010 / 11, around 25 percent of the 50 million or so mortgage holders had loans larger than the value of their houses. in new zealand, losses from housing loans in the wake of the gfc were well contained compared to many countries, although there was an increase in defaults. the reserve bank recently analysed data on banks ’ loss rates, by lvr category, over the period from 2008 to 2012. the increase in loss rates followed a fall in nominal house prices of around 10 percent from their peak in 2007. while there was some variation across banks, the data shows that loss rates on high - lvr loans generally increased more ( and in several cases substantially more ) than loss rates on lower lvr loans. this evidence of high and correlated loss rates supports the proposition that higher lvr loans have more systemic risk than lower lvr loans. it is on this basis that the reserve bank recently took the ( micro - prudential ) measure of increasing high lvr risk weights on the housing exposures of the major banks ( rbnz, 2013c ). bis central bankers ’ speeches a number of countries have applied lvr restrictions over the past few years, including canada, sweden, norway, israel, korea and hong kong sar. in the case of sweden and norway, the lvr restrictions are

to include nonbank financial institutions. one factor that will constrain these alternative channels is the cost of funding. unsecured lending is considerably more expensive than mortgage lending, and non - bank funding is more expensive than bank funding. in sweden, for example, it is quite common for households to borrow a portion of house purchase costs via an unsecured topup loan, and that activity increased when lvr restrictions were applied in 2010. but the borrowers who do that need to consider the higher interest rate on unsecured funds as well as the more rapid repayment of their top - up funds relative to their main mortgage. in this way there can be significant deterrent effects built into avoidance channels. the cooperation of the banks in implementing any lvr restrictions would be crucial for their success. we would expect bank management and directors to follow the spirit, not just the letter of the restrictions. in particular, they would need to ensure that the policy was not abused or undermined through innovative lending practices. certainly we would be maintaining a close dialogue with the banks. removal of restrictions when would an lvr restriction be removed? this would need to be assessed in light of the assessed impact of the restrictions on housing lending, house price pressures and the riskiness of bank balance sheets. once the housing market returned to a better balance of supply and demand, the restrictions would be removed. alternatively, we would look to remove the restrictions if they were judged not to be achieving their purpose of reducing systemic risk and / or if they were causing material distortions. if we saw a sharp correction in house prices, there would be a clear case for promptly removing any lvr restrictions. in that situation there would be little risk that removal of the restrictions would result in a resurgence of risk appetite. for example, the correction in house prices after 2007 resulted in a sharp decline in both the demand and supply of high lvr lending, suggesting that an lvr restriction would not have been necessary during this period. a preferred outcome would be a “ soft landing ” in the housing market, where house price growth moderates without resulting in a sharp correction. in that situation, the reserve bank would need to carefully weigh the efficiency benefits of removing any lvr restrictions against the risk that this might stimulate a renewed build - up of systemic risk. a persistent moderation in household credit growth would argue in favour of removal. conclusion we at the reserve bank see the current overheated housing market as a real threat to future