By David Chaston
Over the past twenty five years or so, most banks have shifted the focus of their lending towards residential property.
From their point of view, houses are an asset that has a ready market. That liquidity allows them to take possession of their security if the borrower defaults and relatively easily recover their loan.
Twenty five years ago, the situation was quite different. Most banks focused on lending to businesses. Mortgage lending was a relatively small portion of their loan portfolio.
But in 2003/4 there was a substantial shift.
House prices had been rising quickly starting in 2003 and for the next four years, prices rose much faster than +10% per year.
And the market started to feel the impact of an aggressive new CEO at ASB. Ralph Norris taught NZ banking the benefits of customer service. He took a regional savings bank and made it a powerhouse of innovation, especially for mortgage lending. His successors pushed the idea, taking the bank national, and forcing all their rivals to raise their game. The chief battleground was in home loans.
And this was at a time a new higher income tax rate was introduced. Prior to 1984, New Zealand had relatively high income tax rates and this spawned a vast industry of advisers on how to minimise the burden. This all had to be done within a tight wall of isolationism. But when New Zealand was freed from these restrictions, the income tax rate was reduced substantially, making tax avoidance less attractive and not worth the costs.
However, the impulse was established. The raising of the top tax rate to 39% in 2000 and making it apply from $60,000 brought the impulse back to the mainstream.
Without a capital gains tax, “investment in houses” became a favoured alternative to mainstream investing, especially by “mum and dad” investors. Many support companies mushroomed to encourage the obvious advantages, especially when capital gains ran on for years.
And banks followed.
At the same time, the regulatory framework gave the trend a substantial boost. Regulators reduced the amount banks had to set aside in capital to support housing loans dramatically. Only half the capital was needed for a housing loan than for an equivalent business loan. The rationale was the liquidity in the real estate markets and the relative ease in cleaning up bad loans. The BIS’s Basel frameworks gave international credibility to the shift.
Unbelievably, an update on the eve of the GFC saw a second shift where banks were then given permission to calculate their own risk weightings. In many cases this took the capital requirements down from a half to under 30%, where it sits today.
These two trends turbocharged mortgage lending by banks.
Lending to businesses did not stop, or even slow down. That grew as well, but just not as fast. That track gives a useful insight to how much extra has been added by the twist favouring lending for houses. By 2017, that extra has grown to almost $60 bln.
The latest data shows that we are now at a record high in our banks exposure to mortgage lending.
Another important influence has been the emergence of very low interest rates. These have been imposed on New Zealand by the aggressive use of unconventional monetary policy (money printing, or “quantitative easing”) by the central banks of the world’s largest economies. It started in Japan, took off during the GFC in the USA and the EU, and none of these programs have yet found an effective way to turn off the tap. Money became very plentiful and very cheap. And cheap money has driven up asset prices, including those for residential land. It is an effect keenly felt in New Zealand, even though we have never engaged in money printing. (The closest we came was through a loose fiscal policy during the GFC. That ended when substantial surpluses returned.)
Our banks have almost all been converted from balanced trading banks to essentially mortgage banks. Most of their loans are for housing. Some, like Kiwibank and the small locally-owned banks are more than 80% exposed to housing loans.
Even the big banks can now be best described as ‘mortgage banks’, rather than traditional trading banks. ANZ, ASB and Westpac all qualify. BNZ is the only New Zealand bank where lending for housing is a smaller proportion than its lending to businesses.
By allowing banks to follow the money, our banking supervision has permitted a substantial twist in the way we now assess economic risk to our economy.
It will take a long time to return to a more normalised balance. (And fortunately, the RBNZ seems to be wanting to move back that way.)
And in the meantime, if capital gains in housing evaporate, and housing equity levels start to fall, that twist may develop a negative feedback loop.
In that case, ‘normalising’ may require more pain that should have been necessary.
And that will be the cost of converting housing from ‘accommodation’ to being a financial investment.
(And readers may also have noticed the trend drop in non-housing lending in the graph above. This is not a good development.)