The central bank of Ireland is rumoured to be interested in imposing loan to value limits, as well as loan to income limits, on mortgages. The objective here, it appears, is to try and cool down the housing market in Dublin.
A big part of the problem in the Dublin market, which is going gangbusters, is a shortage of supply. Lots of reasons given for this shortage of supply, such as the cost of house building is still too high relative to what can be achieved, the lack of serviced land, the willingness of banks to lend working capital for property development etc. Be that as it may, the supply-side issues will take time to work through. Will loan to value limits work?
A paper published in 2013 finds that loan to value limits are amongst the most popular of macro prudential policies. At some stage since 2000 44% of countries were using them. The authors find that the effect of such tools as loan to value limits is to reduce bank leveraged and risk therefore of future problems, particularly when they’re introduced during a boom period. There are downside effects, with a Korean study suggesting that banks eventually find a way around this loan to value limits and they have limited effect, in the long term, on house price growth in the boom areas.
Loan to value limits can be useful, it seems, in curbing house price growth. Some recent suggestions indicates that a 10% increase in global loan to value ratio is associated with 13% increase in nominal house prices. Korea introduced loan to value limits in 2002, and what followed was a stopping of house price increases, at least for 6 to 8 months. The Korean experiment was also associated with reduction in transactions. An important point from the Korean experience is that while the effect may be relatively short, there is a longer run impact on people’s expectations. There’s a lot of evidence that suggests that expectations, expectations of further house price increases in particular, play a huge role in bubble dynamics.
In New Zealand the reserve bank has recently introduced loan to value restrictions, and they provide a nice info graphic of how they expect these to work, the effects they expect them to have, and on what elements. Overall they expect these loan to value restrictions to reduce house price growth.
Finally, a study of 57 housing markets, over three decades, looked at non-interest rate related policies. In terms of curbing housing credit growth, loan to value ratios are seen asuseful, although not as useful as limits on debt service capability. But in terms of house prices, and remember that in Ireland right now we don’t have a problem with regard to credit but we do have a problem with regard to prices, only taxation based interventions seems to really cool prices. The likelihood of any Irish government increasing housing taxes in the run-up to an election is zero.
Claessens, S., Ghosh, S. R., & Mihet, R. (2013). Macro-prudential policies to mitigate financial system vulnerabilities. Journal of International Money and Finance, 39, 153-185.
Igan, Deniz, and Heedon Kang. Do Loan-to-Value and Debt-to-Income Limits Work?: Evidence from Korea. No. 11/297. International Monetary Fund, 2011.
Kuttner, Kenneth N., and Ilhyock Shim. Can non-interest rate policies stabilize housing markets?. No. 2013-20. 2013.
Park, S. W., Bahng, D. W., & Park, Y. W. (2010). Price run-up in housing markets, access to bank lending and house prices in korea. Journal of Real Estate Finance and Economics, 40(3), 332-367.
Rogers, Lamorna. “An A to Z of loan-to-value ratio (LVR) restrictions.” Reserve Bank of New Zealand Bulletin 77.1 (2014).
rowe, C., Dell’Ariccia, G., Igan, D., & Rabanal, P. (2013). How to deal with real estate booms: Lessons from country experiences. Journal of Financial Stability, 9(3), 300-319.