Norges Bank’s consultation response – Assessment of the regulation on requirements for new residential mortgage loans

Norges Bank refers to the consultation letter of 10 September 2019 from the Ministry of Finance requesting comments on the proposal by Finanstilsynet (Financial Supervisory Authority of Norway) to retain the regulation on bank credit standards with a tightening of certain standards. The current regulation entered into force on 1 July 2018 and applies until 31 December 2019.

Norges Bank also refers to its letter of 16 August 2019 with attached analysis to Finanstilsynet containing the Bank’s assessment of the regulation.[1] In the letter, Norges Bank concluded: “In Norges Bank’s opinion, the current residential mortgage loan regulation has functioned as intended and developments do not suggest a need for material changes to the requirements. In the view of Norges Bank, the regulatory requirements should be the same across the country.”

Finanstilsynet proposes that the maximum debt-to-income (DTI) ratio requirement be reduced from 5 to 4.5 times annual income. Finanstilsynet further proposes that banks’ flexibility quota, ie the option to extend loans that do not meet one or more of the criteria in the mortgage loan regulation, be set at 5 percent across Norway. Pursuant to the current regulation, this quota is up to 10 percent of the value of mortgage loans approved each quarter, with the exception of residential mortgage loans in Oslo where the quota is 8 percent. Finanstilsynet also proposes revoking the specific requirement for a maximum loan-to-value (LTV) ratio of 60 percent for loans secured on secondary homes in Oslo. The proposals thus entail removing the geographic differentiation under the regulation. Finanstilsynet proposes retaining the regulation without a time limit.

Assessment

High household debt is an important source of vulnerability for the Norwegian economy (see Financial Stability Report 2018). Owing to the high level of debt, many households may need to reduce consumption in the event of a pronounced decline in house prices, a loss of income or a rise in lending rates. This may amplify a downturn in the Norwegian economy and increase banks’ losses on commercial loans.

Regulation must strike a balance between the aim of credit market efficiency and the aim of mitigating the build-up of risk in the financial system. Requirements imposed on banks’ lending practices can dampen the build-up of household sector vulnerabilities. On the other hand, requirements on lending practices interfere with banks’ room for discretion. Standardised requirements can have an undesirable impact in individual cases, can weaken banks’ incentive to take independent responsibility for assessing risk and can be normative. Regulating lending practices may also lead to the provision of credit from new sources or in new forms that are not covered by the regulation.

In the opinion of Norges Bank, the inclusion of a flexibility quota in the regulation has sufficiently taken these assessments into account. The regulation has provided a clear limit for prudent residential mortgage lending and limited banks’ lending to vulnerable households. At the same time, the flexibility quota has enabled banks to extend loans in breach of the regulatory requirements based on customer-specific assessments. The flexibility quota also reinforces banks’ own responsibility for prudent lending practices. There is no clear indication that residential mortgage loans are increasingly being provided by sources outside of the regulated banking sector, but consumer credit extended by banks may have been used for home purchases. The new credit registers for consumer credit will prevent households from taking out consumer credit to meet equity requirements for obtaining a residential mortgage.

Household debt has long risen faster than income. In recent years, debt growth has decreased somewhat while household income growth has risen. House price inflation has also been moderate in recent years and house prices relative to household disposable income have declined since 2017. Looking ahead, the higher interest rate level and continued moderate house price inflation are expected to curb debt growth further.

Finanstilsynet proposes tightening the maximum DTI ratio requirement and points to high and rising DTI ratios in the residential mortgage lending survey. The most recent available tax return data, which are for 2017, indicate rising DTI ratios among both homebuyers and household groups that are not purchasing homes. Among first-time buyers in 2017, approximately 35 percent were assigned DTI ratios between 4.5 and 5. For households overall, this share was just over 2 percent. Tax return data show that the share of households with DTI ratios between 4.5 and 5 was highest among households in lower and middle income groups. Reducing the maximum DTI ratio requirement from 5 to 4.5 will restrain the build-up of household sector vulnerabilities. At the same time, such tightening will limit the supply of credit to creditworthy households.

Banks have made use of the flexibility quota, which allows them to extend loans in breach of the requirements. Figures from Finanstilsynet’s consultation document indicate that a reduction in the flexibility quota from 10 percent to 5 percent will also have some tightening effect if the requirements in the regulation are retained without revision. In the consultation document, Finanstilsynet notifies that it will “provide further guidance in a circular on the regulation’s wording  about ‘normal living expenses’” for the calculation of borrowers’ debt-servicing capacity. Such guidance will contribute to more consistent bank practices, but will likely have a tightening effect compared with current practices.

Norges Bank is of the opinion that the tightening proposed by Finanstilsynet of the maximum DTI ratio requirement and the flexibility quota will constitute a significant overall tightening of the regulatory requirements. Norges Bank is of the opinion that the maximum DTI ratio requirement should not be changed.

The requirements in the residential mortgage loan regulation should be based on a judgement of the trade-off between the consideration of dampening the build-up of vulnerability and overall credit market efficiency. With a flexibility quota that provides banks with sufficient room to make customer-specific assessments, responsibility for prudent lending in each individual case is placed on the banks. This involves rejecting loan applications from borrowers who do not breach regulatory requirements, but who the bank nevertheless identify as vulnerable. The tighter the standardised regulatory requirements are, the more important it is that banks are given the flexibility to make their own credit risk assessment.

In, for example, the consultation response of 4 May 2015, Norges Bank expressed the opinion that “[...] prudent mortgage lending requirements should be regarded as a permanent structural measure and should not be changed frequently”. The authorities’ aim should not be to fine-tune developments in house prices and credit. In principle, the requirements in the regulation should not vary.

Norges Bank supports changes to the regulation to provide nationally consistent requirements. The regulation becomes more complex with region-specific requirements. Equity capital requirements for secondary home purchases in Oslo have likely had a dampening effect on purchases of residential property for investment purposes. The specific flexibility quota for Oslo may have helped curb debt growth. Removing the regional requirements can thereby ease the regulation. An alternative could be to make the LTV requirement for secondary home purchases applicable throughout Norway. Some reduction of the flexibility quota could also be considered, for example to 8 percent, which is currently the quota for Oslo.

Norges Bank supports the same maximum DTI ratio requirements in the regulation on requirements for new residential mortgage loans and in the regulation on requirements for financial institutions’ consumer credit standards. The consumer credit regulation should therefore be adjusted if the Ministry of Finance changes the DTI ratio requirement in the residential mortgage lending regulation, as proposed by Finanstilsynet. In the consultation document, Finanstilsynet mentions that they will consider statutory rules for non-mortgage lending. Norges Bank supports consistent requirements for credit standards for all types of retail lending in order to prevent regulatory avoidance. It should be assessed whether the requirements for different types of lending can be consolidated into one regulation.

Norges Bank supports that the regulation should apply for an indefinite period of time. The costs and benefits of the requirements for credit standards can change over time or may change owing to changes in other regulations and market conditions. Requirements in the residential mortgage loan regulation should therefore be assessed at regular intervals without limiting the duration of the regulation.

Sincerely,

Øystein Olsen
Governor                   

Torbjørn Hægeland
Executive Director

Attachment: Charts (pdf) (In Norwegian only)

Footnotes

1) The letter is part of the consultation document including the proposal for a new regulation.