Interest rates, housing bubbles and macroprudential regulation: the Kiwis say it is All Black and white

The missives of central bankers around the world are now studied with the same sort of intensity medieval scholars devoted to understanding the ancient texts. The legion of mystic druids of financial markets study the entrails seeking guidance from the gods on what “normal” and “patient” might mean for interest rates.

So the decision by Australia’s central bank to maintain its key overnight cash rate at 2.25 per cent on Tuesday, despite all the signs pointing otherwise, provoked an outpouring of interpretation.

"he monetary shamans were not all so restrained, particularly those who worship on the altar of Twitter."
Andrew Cornell, Managing Editor

For example, our own diviners here at ANZ Research pronounced “we must conclude that the Reserve Bank is much more cautious with monetary policy than we previously thought and that the hurdle for rate cuts may be higher than generally recognised”.

The other monetary shamans were not all so restrained, particularly those who worship on the altar of Twitter, with one particularly strong theme being the RBA held off for fears of igniting a housing bubble no doubt filled with inflammable gases.

The bank itself made no such comment. Indeed, in recent times it has released material arguing those Australians who buy the most expensive houses are not the most vulnerable to debt while other data shows house price inflation in Australia is not uniform and indeed is concentrated in some of the more affluent suburbs of Sydney and Melbourne – where it should be noted many commentators either live or aspire to live.

It's often said monetary policy is a blunt instrument and nor is it the only one at the regulators' disposal.

If particular pockets of house price inflation are the concern, other tools can be used. One has been in New Zealand – successfully in the view of its central bank. A 'macroprudential” policy, designed to cut the amount of more highly leveraged mortgages being written which in turn was pushing up house prices, was introduced in New Zealand in 2013.

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According to RBNZ deputy governor Grant Spencer, “we are comfortable that the restrictions are so far meeting their objective of helping to restrain the demand for housing while supply gradually catches up”.

“In so doing, we believe the restrictions are mitigating the systemic risk of a housing market downturn that becomes more likely as house prices and debt levels become more stretched,” he said in a review of the housing market last year.

“We also believe that the Loan-to-Valuation ratio restrictions [the particular macroprudential tool used] have helped to make banks' balance sheets more resilient to any adverse housing market shock.”

Australian regulators are not so convinced and indeed Australia's central bank Guv Glenn Stevens did refer to macroprudential tools as a policy “fad” at one point. Even the Kiwis concede macroprudential tools become less affective over time and will phase out this one.

But that's not to say Australia's regulators, not just the RBA but the Australian Prudential Regulation Authority, are restricted to just monetary policy – and hence that decisions like Tuesday's market-surprising decision to hold rates are so singularly hitched to house prices.

Regulators are rarely so direct.

Indeed, more time should have been spent by the various seers, prognosticators, soothsayers and haruspices on recent utterances by APRA chair Wayne Byres.

For those interested in how a regulator might respond to discrete rather than universal risks, Byres told the House of Representatives Standing Committee APRA had written to all Australian Approved Depository Institutions (mainly banks) “encouraging” them to “maintain sound lending standards”.

He noted APRA has identified some benchmarks it will be using to measure performance against such standards. Transgressors may then be dealt with individually. Byres also accepted higher capital levels may be required in the system.

“I would like to emphasise that, in alerting ADIs to our concerns in this area, we are seeking to ensure emerging risks and imbalances do not get out of hand,” he said. “We are not targeting house price levels - as I have said elsewhere, that is beyond our mandate - and we are not at this point asking banks to materially reduce their lending.”

Under follow up questions, Byres used language which, were his vowels a little more clipped, could equally have come from a central banker across the ditch in New Zealand.

He said the possible measures were “targeting those (banks) that are pursuing the most aggressive lending strategies and to the extent there is extra capital imposed, that will be imposed on those housing portfolios where the risks are".

Byres then reminded the committee – and they and everyone else shouldn't have needed reminding – that when APRA moves it doesn't announce it publicly and actually threatens institutions with retribution if they reveal measures themselves. The favoured occult tool is the “prudential capital ratio”, an extra layer of capital.

"Consistent with the fact we don't want to advertise that any financial institution might have some issue that requires our intervention, we do not disclose that and, within our powers, we have the capacity to tell [banks] that they should not disclose it as well," he said.

While they should've known this long standing practice, the pollies on the panel sought an explanation and Byres said he felt such policy was more affective “below the radar” and APRA was likely to get more cooperation and disclosure from the banks if the capital ratio adjustments were not made public.

As astute market analyst Sean Keane from Triple T Consulting said at the time in his note to Credit Suisse clients “the secret approach is a novel one in the current climate when everything is fully disclosed and most regulators have taken the name and shame approach to getting banks to do what they want them to”.

“The effectiveness of this has been questioned by those with longer memories who recall the 'quiet word' days of regulatory oversight, when things happened in the background without resulting in 24 hour banner news headlines,” Keane argued.

“Whilst such a private adjustment might be preferable for the banks themselves it's unlikely to remain secret for very long (and) it's probably also the case that the analyst community would very quickly detect changes in market share and prudential capital levels that would indicate that restrictions are in place.

“They might reasonably ask the question also as to why the bank isn't telling investors its earnings stream might be lower than forecast because of the higher capital provisions that APRA has applied.”

It should be noted Keane, perspicacity aside, is a Kiwi.

APRA's reticence on this front is however longstanding. Moreover, the market has over time worked out the broader definitions of where the policy is in place – although interestingly never with the fidelity Keane predicts.

But following the surprise of this week's monetary policy decision by the RBA, the over-riding lesson is the regulators are not always predictable and certainly not always scrutable.

US Federal Reserve Governor Janet Yellen made the point that even though the Fed had dropped the word “patient” from its own missives, that didn't mean it would become “impatient”.

Australia's Stevens had his own shot: “The fact that it isn't interest rates holding things back isn't the same thing as saying that there's no benefit from lowering them. There might be."

That was not said this week. But it may well have been given the wording of this week's policy statement was almost identical to the last. And neither said the bank's arm was dependant on Sydney and Melbourne house prices.

According to ANZ chief economist Warren Hogan in his note: “There is a reference to housing credit (and in particular investor housing credit) not picking up recently, which implies that the RBA's degree of concern around the housing market has not stepped up and was not the reason for holding off today.

“They see the rise in house prices as uneven with Sydney still performing well. The Governor reiterated that they are working with other regulators to 'contain risks that may arise from the housing market'.”

Over to you Wayne…

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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