RDP 2021-07: Macroprudential Limits on Mortgage Products: The Australian Experience 1. Introduction

Twice between 2014 and 2018, the Australian Prudential Regulation Authority (APRA) temporarily restricted banks' lending in mortgage types considered systemically risky. The first policy, announced late 2014, required banks to limit their lending to housing investors, or in other words, ‘buy-to-let’ borrowers that will rent out the housing. The second policy, announced early 2017, imposed limits on interest-only (IO) mortgages, in which the loan principal stays constant and only interest is repaid. APRA (2019b) describes the policies as ‘tactical, temporary constraints’, because they were designed to act fast and target the specific sources of systemic risk. Credit was expanding rapidly in residential mortgage products considered procyclical, while housing prices and household debt were high and rising (Debelle 2018; APRA 2019b). The limits were later removed, replaced by longer-term solutions.^[1]

Macroprudential credit growth limits are backed by a deep literature tying credit growth to financial crises. Research shows that excessive credit growth is the most consistent antecedent of financial crises (e.g. Borio and Lowe 2002; Reinhart and Rogoff 2011; Schularick and Taylor 2012). Speculative mortgage debt and housing price cyclicality were fundamental ingredients in the 2008 financial crisis (Adelino, Schoar and Severino 2016; Foote, Loewenstein and Willen 2021), and contributed to crises further back (Dell'Ariccia et al 2012; Richter, Schularick and Wachtel 2021). The evidence has led to policy action. A variety of macroprudential tools have been implemented to curb excessive or risky credit (e.g. Cerutti, Claessens and Laeven 2017), including many specifically targeting mortgage lending (e.g. Kuttner and Shim 2016).

To our knowledge, none of these policies have targeted overall growth in particular mortgage products, aside from APRA's.^[2] APRA's first policy required each bank to limit its year-ended growth in investor housing credit to 10 per cent. The second policy required each bank to limit its quarterly new IO mortgage lending to 30 per cent of total new housing lending. Most policies in other countries have set quantitative requirements only on loans above specific loan-to-valuation ratios (LVRs) or loan-to-income ratios (LTIs). APRA did present guidance that banks should manage new lending at high LVRs and LTIs, but quantitative limits were only set for the specific mortgage products. This was for a few reasons: high LVR lending was already in decline, limits on high LVR loans can disproportionately affect first home buyers, and the main risks appeared concentrated in speculative and IO borrowing (Ellis and Littrell 2017; APRA 2019b).

Our paper presents a bank-level panel data study of banks' reactions to the policies. We present causal statistical evidence, with falsification tests, that the policies reduced growth in the policy-targeted mortgage products. Banks cut lending growth in targeted mortgages by around 20 to 40 percentage points within a year of the policy announcements. While conclusions about systemic stability are outside this paper's scope, the findings are consistent with the policies achieving their objectives. We also present 3 conclusions, which build on existing qualitative analysis of the policies by the Australian Competition and Consumer Commission (ACCC), APRA and the Australian Government Productivity Commission (PC):

1. Banks cut back targeted mortgage types by raising interest rates on those mortgages. This has been noted by, for example, ACCC (2018a, 2018b). We contribute by presenting causal statistical evidence, which estimates policy-induced rises in advertised rates of around 10 to 30 basis points, and by tying together banks' quantity and price responses. These rate rises partly reflected a desired repricing of risk, although ACCC (2018a, 2018b) also argue that the policies presented a focal point for coordinated anti-competitive price changes. We find that banks' mortgage interest income rose after the IO policy, in line with the ACCC's conclusion, but that the effect was short-lived.
2. Banks' policy reactions depended on their size. Large banks – that is, the 4 Australian major banks – substituted into non-targeted mortgage types, and sustained their overall mortgage growth. The 20 or so other (mid-sized) banks in our sample did not substitute and their overall mortgage growth declined. These bank-level patterns are statistically significant but, in aggregate, coincide with only a small temporary pick-up in large banks' mortgage market share relative to the other sample banks. To our knowledge we are the first to show that banks' credit allocation reactions to macroprudential policies depend on their size.
3. Implementation difficulties significantly influenced how the policies played out. Banks reacted to the investor policy with a 2-quarter delay, and their reaction sizes were misaligned with the policy impositions. These results support conclusions in previous regulatory reports that banks' systems initially lacked the capacity to control growth in the targeted mortgage types, and, for mid-sized banks, this imperfect control was compounded by heavy customer flows from the large banks' policy reactions. Contacts also tell us that some banks were uncertain about the precise definition and time frame for the investor limit, which contributed to the delayed reactions. Practical difficulties were less prevalent for the IO policy, after banks had improved their systems, and with the policy worded more precisely.

Our work presents several other results. Analysis of aggregate credit indicates that the policies had little effect on overall housing credit growth – with large banks substituting across housing credit types – and, if anything, a positive effect on business credit. Analysis of granular mortgage categories reveals that the accompanying guidance on high LVR lending, mentioned above, interacted with the quantitative limits: the decline in targeted housing credit was concentrated in high LVR loans, and substitution into non-targeted housing credit was concentrated in low LVR loans. We also argue that the substitutability between targeted and non-targeted mortgages differed across the 2 policies due to the types of products targeted. While a bank can steer any given customer towards either an IO or a principal and interest (P&I) loan, by offering attractive interest rates (e.g. Guiso et al forthcoming), customers typically cannot switch their status from investor to occupier. Therefore, to substitute from investor to occupier credit, banks need to find other customers, which Acharya et al (2020) call the ‘bank portfolio choice’ channel. This likely made substitution easier under the IO policy relative to the investor policy. More generally, across the full sample we find that IO and investor lending move with housing prices, while occupier P&I lending does not. This is consistent with speculative demand being driven by recently observed price behaviour.

This paper contributes to the growing literature studying the variety of macroprudential credit growth policies implemented around the world. In line with the other policies implemented, most papers focus on the impact of LTI and LVR limits. Results typically show a reduction in the targeted mortgages, particularly by banks exceeding specified limits. Some find that banks under the limits lift mortgage originations, in targeted mortgages (in the United Kingdom, Peydró et al (2020)), or in non-targeted mortgages (in Ireland, Acharya et al (2020)). We find that substitution into non-targeted mortgages is mostly by banks above the limits, which in our sample tend to be the largest banks, with potentially more capability to shift their portfolios. Many studies also find a significant negative effect on housing prices, including in the United Kingdom (Peydró et al 2020), in New Zealand (Armstrong, Skilling and Fao 2019) and in cross-country studies (Kuttner and Shim 2016; Alam et al 2019; Araujo et al 2020). We do not analyse housing price effects, but note that RBA (2018) finds that the investor policy caused housing price growth to slow more in investor-concentrated regions than in occupier-concentrated regions. More broadly, ours and these other papers on credit growth limits contribute to the wider literature on macroprudential policy effects (e.g. Aiyar, Calomiris and Wieladek 2014; Cerutti et al 2017; Jiménez et al 2017).

Banks' use of interest rates to target credit growth has been less studied. Basten (2020) shows that, following the introduction of the countercyclical capital buffer (CCyB) in Switzerland, capital-constrained banks raise their mortgage rates more than others. DeFusco, Johnson and Mondragon (2020) show that US lenders charge a premium of 10 to 15 basis points to originate loans above a regulatory debt-to-income ratio threshold (under the Dodd Frank Act), above which mortgages require extra ‘ability to repay’ documentation. We find interest rate policy effects of a similar magnitude. They also find that banks additionally contained quantities through credit rationing, which led to irregular demand elasticities, and we also find that banks limited credit supply through means other than rate rises.

The rest of this paper is laid out as follows. We first describe the investor and IO policies (Section 2). As background for the analytical results, the next sections explain the dataset and the variables of interest (Section 3) and the econometric models we use (Section 4). Then we report results for policy effects on banks' credit growth and interest rates, first for the investor policy (Section 5), and then for the IO policy (Section 6). Section 7 presents findings for other outcomes of interest: banks' LVR distributions (7.1); aggregate credit trends (7.2.1); banks' housing credit market shares (7.2.2); banks' mortgage pricing power (7.2.3); borrowers' reclassifications of mortgage types (7.3); and, more generally, the cyclicality of mortgage behaviour throughout the sample (7.4). Section 8 concludes.

Footnotes

These include proposals to differentiate capital risk weightings by mortgage types (APRA 2020) and APRA's July 2019 amendments to official guidance for banks on sound residential mortgage lending (APRA 2019a). [1]

The closest to APRA's appears to be Singapore's 2009 ban on IO mortgages, described in Upper (2017). [2]