Loan-to-value ratio as a macroprudential tool Hong Kong SAR s experience and cross-country evidence

Transcription

1 Loan-o-value raio as a macroprudenial ool Hong Kong SAR s experience and cross-counry evidence Hong Kong Moneary Auhoriy I. Inroducion The global financial crisis has demonsraed ha moneary policy and microprudenial banking regulaions by hemselves are no sufficien o preven he build-up of sysemic risk. 1 There is a growing consensus ha macroprudenial policy should complemen he exising policy frameworks of cenral banks and supervisory auhoriies designed o address sysemic risk (Bank of England (2009), Caruana (2010b), Jordan (2010), Papademos (2010) and Srauss-Kahn (2010)). Some counries for example, Hungary, Norway, Sweden and he Unied Kingdom are considering adoping, or have recenly adoped, maximum loan-o-value (LTV) raios on morgages (henceforh referred o as LTV policy) as a macroprudenial insrumen o fill he policy gap. 2 Despie wider recogniion in he policy communiy of he effeciveness of LTV policy, empirical evidence wih regard o he following key issues remains scan. 3 Firs, how effecive is LTV policy in reducing sysemic risk generaed by boom-and-bus cycles in propery markes? Second, does LTV policy creae significan liquidiy consrains for poenial homebuyers, some of whom migh no qualify for a morgage afer making he sizeable down paymen required under LTV policy despie heir abiliy o repay he loan iself (see Financial Services Auhoriy (2009))? Third, can a morgage insurance programme (MIP) 4 offse his drawback of LTV policy, allowing banks o offer morgage loans wih LTV raios higher han he maximum hreshold wihou incurring addiional credi risk? Or do MIPs reduce he effeciveness of LTV policy? The objecive of his noe is o provide empirical evidence based, in par, on Hong Kong SAR s experience wih boh LTV policy and MIPs 5 and, in par, on economeric analysis of panel daa from 13 economies. In Secion II, we discuss he hisory of LTV policy in Hong Kong, presening srong evidence ha i has helped he Hong Kong banking secor weaher he boom-and-bus cycles of he propery marke during he pas wo decades. We also presen evidence ha Hong Kong s MIP has helped homebuyers overcome he liquidiy According o Caruana (2010a), sysemic risk is he risk of disrupion o financial services ha occurs because of he impairmen of all or par of he financial sysem and which can have serious negaive consequences for he real economy. Hungary, Norway and Sweden have recenly adoped LTV policies (see Magyar Nemzei Bank (2010), Norges Bank (2010), and Swedish Financial Supervisory Auhoriy (2010)). The UK Financial Services Auhoriy (2009) has no ruled ou he possibiliy o employ such a policy in he fuure. The pracice of LTV policy across counries, and he role of LTV policy in miigaing he amplificaion of credi-asse price cycles and in proecing banks from he disrupive effecs of he cycles, are discussed in Borio e al (2001). Throughou his sudy, he erm MIP refers o insurance ha aims o proec lenders agains losses due o morgage paymen defaul by borrowers. In some jurisdicions, i is known as lenders morgage insurance. Hong Kong s experience in his area is LTV policy has been in effec for nearly 20 years; propery prices in Hong Kong are subjec o frequen and subsanial swings; and Hong Kong banks have significan exposure o propery-relaed lending offers an unparalleled opporuniy o assess he long-run prudenial effec of LTV policy on banking sabiliy. In addiion, since Hong Kong is precluded from exercising an independen moneary policy under he Linked Exchange Rae Sysem, LTV policy plays a predominan role in safeguarding banking sabiliy. BIS Papers No

2 consrains hey may experience because of LTV policy wihou increasing he banking sysem s exposure o credi risk. The policy implicaions are discussed in he conclusion. As shown in Annex A, economeric analysis of panel daa from 13 economies bears ou Hong Kong s experience wih LTV policy and MIPs. I shows ha LTV policy enhances banking sabiliy, mainly by reducing he responsiveness of morgage defaul risk o propery price shocks, and ha MIPs have no reduced he effeciveness of LTV policy. II. A brief hisory of LTV policy and he MIP in Hong Kong LTV policy has long played a vial role in safeguarding banking sabiliy in Hong Kong. I was developed because of he special characerisics of Hong Kong s financial sysem. Firs, residenial morgage lending (RML) has always been one of he larges areas of risk exposure for Hong Kong banks. Since 1991, RML has accouned for a leas 20% of he banking secor s lending o local borrowers, reaching a peak of 37% in Sepember Second, propery prices have hisorically exhibied srong cyclical paerns ha could seriously hreaen banking sabiliy if bank exposure o he propery marke were no properly managed. In fac, Gerlach and Peng (2005) find ha bank lending in Hong Kong is driven largely by propery price movemens, 6 suggesing ha sysemic risk is, o a grea exen, associaed wih developmens in he propery marke. Third, since he Hong Kong Moneary Auhoriy (HKMA) is precluded from conducing an independen moneary policy under he Linked Exchange Rae Sysem, i mus devise alernaive policies for managing he sysemic risk semming from banks exposures o propery markes. LTV policy was inroduced as an insrumen for srenghening he banking sysem's resilience o asse price volailiies and reducing he risk of cycle amplificaion hrough bank credi, raher han as a means of managing asse price cycles and marke aciviies or argeing asse prices. 6 Gerlach and Peng (2005) conduc Granger causaliy ess for propery prices and bank lending in Hong Kong. They find ha propery prices Granger-cause bank lending bu no he oher way around. 164 BIS Papers No 57

3 Maximum LTV raio % 70% % PV = propery value Source: HKMA. Graph 1 LTV policy, propery prices and morgage delinquency raio in Hong Kong SAR Maximum LTV of 70% is adoped as a long-erm regulaory policy in 1995 All properies Since 1991 maximum LTV raio of 70% has become an indusry sandard PV<=HK$ 12 m Index value in Oc 1997 = All properies PV>=HK$ 20 m PV>HK$ 12 m HK$ 8 m <=PV< HK$ 12 m PV>=HK$ 12 m or non-owner-occupied properies Price index for luxury properies (lhs) 90-day delinquency raio (rhs) PV<HK$ 8 m PV<HK$ 12 m PV<HK$ 20 m Maximum LTV 4.0 raio % % % Price index for mass properies (lhs) % 1.0% 0.5% 0.0% Graph 1 provides a succinc visual summary of he developmens in Hong Kong s LTV policy, ogeher wih changes in propery prices and morgage delinquency raios. The developmen of LTV policy in Hong Kong can be broadly divided ino four phases, as summarised below: Phase 1: before 1997 Prior o he adopion of he LTV policy in 1991, Auhorized Insiuions (AIs) 7 in Hong Kong were allowed o gran morgage loans covering up o 90% of he purchase price or he marke value of a propery (whichever was lower) under he Third Schedule of he Banking Ordinance, he legal framework for banking supervision in Hong Kong. In view of he sysemic risk ha could arise from RML, he Commissioner of Banking had inended o amend he Third Schedule o lower he 90% LTV hreshold o 70% and issued a guideline advising banks o adop a 70% LTV raio for RML. The Commissioner of Banking consuled he banks during 1991 on hese inenions. Banks were very co-operaive, offering o adop he 70% LTV policy volunarily, removing he need o amend he Third Schedule. 8 The 70% maximum raio has since been fully endorsed by he Hong Kong Governmen as a prudenial measure and has evolved ino a banking indusry sandard inended o guard agains overexposure o he propery marke. On 2 November 1995, he Hong Kong Governmen 7 8 AIs are insiuions auhorised under he Banking Ordinance o carry on he business of aking deposis. All AIs in Hong Kong are supervised by he HKMA. See Commissioner of Banking (1991, 1992). BIS Papers No

4 confirmed a a Legislaive Council meeing ha he 70% LTV raio should be adoped as a long-erm regulaory policy. Phase 2: from 1997 o 1999 Agains he backdrop of a sharp rise in residenial propery prices in 1996, signs of speculaive aciviies (paricularly a he upper end of he propery marke) and he rapid increase in RML, 9 he HKMA issued guidelines o all AIs on 28 January 1997 recommending he adopion of a maximum LTV raio of 60% for properies wih a value of more han HK$ 12 million so-called luxury properies. In he wake of he Asian financial crisis, Hong Kong s propery prices fell significanly by more han 40% from Sepember 1997 o Sepember 1998 ye he morgage delinquency raio remained below 1.43%, which is low by inernaional sandards. This fac alone suggess ha LTV policy reduces he credi risk faced by banks and assures he qualiy of banks morgage loan porfolios. Phase 3: from 1999 o 2008 Afer he Hong Kong Governmen implemened measures inended o sabilise he propery marke, he HKMA abandoned he 60% LTV raio for luxury properies in Ocober 2001 and resored he maximum LTV raio of 70%. A he same ime, he HKMA allowed AIs o refinance he morgage loans of homeowners wih negaive equiy for up o 100% of he curren marke value of he morgaged propery. Nowihsanding his relaxaion of he rules, he HKMA emphasised ha he 70% LTV policy remained generally appropriae as a longerm prudenial measure. Because household income also declined significanly afer he Asian financial crisis, prospecive homebuyers faced significan obsacles in he housing marke, which led o calls for he relaxaion of he 70% LTV policy. In 1999, he Hong Kong Morgage Corporaion (HKMC) 10 launched an MIP aimed a promoing wider home ownership. Under he MIP, morgage loans of up o an LTV raio of 90% were made available o homebuyers meeing cerain eligibiliy crieria. 11 The MIP is designed o proec paricipaing banks agains credi losses on he porion of loans ha exceeds he 70% hreshold in he even of defaul by morgagors. A he same ime, i avoids he poenial drawback of LTV policy: ha some homebuyers may no qualify for a morgage because of subsanial down paymen requiremens even if hey are able o make heir morgage paymens. The increase in he number of homebuyers paricipaing in he MIP during his period demonsraes ha he MIP has helped a significan number of households overcome liquidiy consrains (Graph 2) and ha concerns abou liquidiy consrains should no be lighly dismissed. And, jus as imporan, in assising homebuyers he MIP has helped he banking secor avoid incurring addiional credi risk Propery prices in Hong Kong increased by 30%, RML by 21%, beween December 1995 and December The HKMC, which is owned by he Hong Kong Governmen, was esablished in Is primary missions are: (1) enhancing he sabiliy of he banking secor by serving as a reliable source of liquidiy, hereby reducing he concenraion and liquidiy risk of morgage lending by banks; (2) promoing wider home ownership; and (3) faciliaing he growh and developmen of he deb securiies and morgage-backed securiies markes in Hong Kong. The crieria include maximum levels for he deb-o-income raio, loan amouns and mauriies. 166 BIS Papers No 57

5 Graph 2 Toal annual new morgage lending by Hong Kong SAR's banking secor and percenage of oal covered by he MIP HK$ m 40'000 36'000 32'000 28'000 24'000 20'000 16'000 12'000 8'000 4'000 % Source: HKMC Toal annual new morgage lending by Hong Kong's banking secor (HK$ m, lhs) Percenage of oal covered by he MIP (rhs) 2 One concern is ha he MIP may reduce he effeciveness of LTV policy because i enables households o increase heir leverage raios, hereby boosing he risk of morgage defauls, in heory, and hence of bank credi losses. In realiy, however, he HKMC s MIP porfolio enjoys a lower delinquency raio han Hong Kong s banking secor, 12 indicaing ha, hanks o pruden underwriing crieria, he MIP has no undermined he LTV policy bu has acually improved he sabiliy of Hong Kong s banking sysem. Phase 4: 2009 o he presen As a resul of srong capial inflows and unusually low ineres raes amid unprecedened quaniaive easing by major cenral banks since early 2009, propery prices in Hong Kong have increased sharply, paricularly a he upper end of he propery marke. As a prudenial measure, he HKMA issued guidelines in Ocober 2009 requiring all AIs o reduce he maximum LTV raio for properies wih a value of HK$ 20 million or more from 70% o 60%. In Augus 2010, o furher safeguard banking sabiliy and help banks manage credi risk 12 The delinquency raio of he HKMC s MIP porfolio reached a hisorical high of 0.39% a he end of Sepember 2003, whereas he raio for he Hong Kong banking secor was 1.05%. BIS Papers No

6 more prudenially, he HKMA applied he maximum LTV raio of 60% o properies wih a value of a leas HK$ 12 million as well as o properies ha are no owner-occupied. To srenghen risk managemen in he banking secor s RML business, he HKMA implemened he following measures on 19 November 2010: (1) i lowered he maximum LTV raio for properies wih a value of a leas HK$ 12 million from 60% o 50%; (2) i lowered he maximum LTV raio for residenial properies wih a value beween HK$ 8 million and HK$ 12 million from 70% o 60%, while capping he maximum loan amoun a HK$ 6 million; (3) i kep he maximum LTV raio a 70% for residenial properies valued a less han HK$ 8 million bu capped he maximum loan amoun a HK$ 4.8 million; and (4) i lowered he maximum LTV raio for all non-owner-occupied residenial properies, company-owned properies, and indusrial and commercial properies o 50%, regardless of heir marke value. Since 1994, Hong Kong has also implemened oher policies wih macroprudenial elemens, for example limiing he AIs exposure o propery markes and seing maximum deb servicing raios 13 for morgage applicans. Deails can be found in Annex B. III. Conclusion This noe assesses some of he mos imporan issues surrounding he use of LTV policy as a macroprudenial ool, including is effeciveness and poenial drawbacks. Hong Kong s experience in his area, and he empirical findings of he economeric analysis of he panel daa, sugges ha LTV policy is effecive in reducing sysemic risk associaed wih boomand-bus cycles in propery markes. Alhough he significan number of homebuyers paricipaing in Hong Kong s MIP indicaes ha LTV policy can lead o liquidiy consrains for some households, empirical evidence shows ha he MIP can miigae his drawback wihou undermining he effeciveness of LTV raios as a policy ool. Thus MIPs play an imporan role in enhancing he ne benefis of LTV policy. More imporanly, poenial liquidiy consrains should no be considered a compelling reason for no adoping an LTV policy o conain he sysemic risk associaed wih propery price shocks. 13 The deb servicing raio is defined as monhly repaymen obligaions as a percenage of monhly income. 168 BIS Papers No 57

7 Annex A: An economeric analysis of he effec of LTV policy on banking sabiliy Empirical specificaions In his annex, we analyse panel daa from 13 economies Ausralia, Canada, Greece, Hong Kong SAR, Korea, Malaysia, he Philippines, Porugal, Singapore, Spain, Thailand, he Unied Kingdom and he Unied Saes using wo economeric models. Model A is specified o examine he effeciveness of LTV policy by esimaing he responsiveness of morgage delinquency raios o changes in propery prices and o macroeconomic flucuaions in wo groups of economies one wih, and he oher wihou, LTV policies. Model B examines wheher MIPs have reduced he effeciveness of LTV policy. Model A: The following fixed-effecs model is used o examine he effeciveness of LTV policy: MD P I P I GDP 3 DTGDP I LTV i LTV i In 6 GDP 4 2 i NLTV i I NLTV i where i and index he economy and ime, respecively. LTV I NLTV (1) I is a dummy variable for economies wih (wihou) LTV policies. The specificaion assumes ha changes in he morgage delinquency raio ( MD ) 14 for economy i a ime are correlaed wih percenage changes in real propery prices ( P ) and real GDP growh ( GDP ). The raio of aggregae morgage deb o GDP (DTGDP) and he change in he ineres rae ( In ) are included o conrol for cross-counry differences in he aggregae level of household leverage and moneary condiions, respecively. 15 Unobservable economy-specific effecs and he remainder disurbance are capured by i and i (wih zero mean and consan variance ), respecively. 2 We hypohesise ha LTV policy reduces he responsiveness of morgage defaul risk o changes in propery prices. This implies ha he esimaed coefficiens of P I LTV and P I NLTV ( 1 and 2, respecively) should be negaive, wih he absolue value of 1 lower han ha of 2. Similarly, we hypohesise ha morgage defaul risk is less responsive o macroeconomic flucuaions in economies wih LTV policies han in hose wihou hem. Therefore, we expec esimaes for 3 and 4 o be negaive, and he absolue value of he former o be smaller han ha of he laer. The sign of he esimaed coefficien of DTGDP ( 5 ) is expeced o be posiive; greaer aggregae household leverage generally indicaes higher defaul risk when oher facors are kep consan. A posiive esimae of 6 is expeced because a higher ineres rae implies a higher deb servicing burden for morgagors. 14 Throughou his sudy, changes are measured from quarer o quarer. 15 Oher insiuional facors such as recourse rules and personal bankrupcy regulaions are likely o affec morgage defauls. The effec of such facors on he morgage delinquency raio is assumed o be capured by he fixed-effec coefficiens of he counries. BIS Papers No

8 Model B: Model B, a modificaion of Model A wih an addiional dummy variable J i included, examines wheher MIPs reduce he effeciveness of LTV policy. J i is defined as 1 if an MIP is in place and zero oherwise. The inclusion of he addiional dummy variable allows us o examine wheher he coefficien esimaes of he economies wih boh an LTV policy and an MIP are saisically differen from hose for economies wih only an LTV policy. The model is specified as follows: MD ( J ) P ( J ) GDP DTGDP i 1 i In 6 I I LTV i LTV i i P GDP 4 2 I NLTVi I NLTV i where i and i (wih zero mean and consan variance 2 ) capure economy-specific effecs and remainder disurbance, respecively. Noe ha here are wo new coefficiens, 1 and 3, in Model B as compared o Model A. 1 is he incremenal sensiiviy of he morgage delinquency raio o propery prices in he economies wih boh LTV policy and an MIP relaive o he economies wih only LTV policy. Similarly, 3 measures he corresponding incremenal sensiiviy o macroeconomic flucuaions. The oher esimaed coefficiens can be inerpreed in exacly he same way as hose in Model A. Our core ineres is in he esimaed value and saisical significance of 1 and 3. A posiive and significan esimae of 1 ( 3 ) would indicae ha MIPs increase he sensiiviy of he morgage delinquency raio o propery prices (macroeconomic flucuaions), suggesing ha MIPs reduce he effeciveness of LTV policy. (2) Daa for esimaions and he esimaion mehod The esimaion sample consiss of unbalanced quarerly panel daa for he 13 economies from Q o Q The main descripive saisics for he daa are shown in Table 1. Daa on he morgage delinquency raio are colleced from he respecive cenral banks, 16,17 whereas daa on propery prices, GDP, governmen bond yields (which are used o proxy for ineres raes) and he GDP deflaor are aken from various daabases, including he BIS, CEIC and IMF (ie Inernaional Financial Saisics) daabases. Real propery prices and real ineres raes are derived from he respecive nominal variables and he GDP deflaor. Of he 13 economies, four Hong Kong, Korea, Malaysia and Singapore have adoped an LTV policy according o he Bank for Inernaional Selemens (BIS (2010)) and informaion obained from heir respecive cenral banks/supervisory auhoriies. Hong Kong, Korea and Malaysia have also implemened MIPs The UK daa, which are obained from he Council of Morgage Lenders, he rade associaion of he Unied Kingdom s morgage indusry, are he only excepion. Morgage delinquency daa for Greece and he Unied Kingdom are available annually and biannually, respecively. Quarerly daa for hese wo counries are derived by inerpolaing he annual/biannual series. We verified ha he empirical resuls are no sensiive o he inerpolaion mehod used. The corresponding insiuions are he HKMC, he Korea Housing Finance Corporaion and Cagamas Berhad, respecively. Cagamas Berhad launched Malaysia s MIP in BIS Papers No 57

9 Models A and B are esimaed using he generalised leas squares (GLS) mehod insead of he ordinary leas squares (OLS) mehod because, in heory, GLS esimaes are more efficien han OLS esimaes given he panel srucure of he daase. 19 Esimaion resuls We firs discuss he esimaion resuls for Model A, which are summarised in Table 2. The esimaed sensiiviy of he morgage delinquency raio o propery prices is negaive and lower (in absolue erms) in economies wih LTV policies ( 1 ) han in economies wihou LTV policies ( 2 ). A 1% drop in propery prices would increase he delinquency raio by 0.35 basis poins in economies wih LTV policies, and by 1.29 basis poins in economies wihou LTV policies. The saisical resuls of he Wald es indicae ha he null hypohesis of 1 = 2 can be rejeced a he 10% significance level for Model A, suggesing ha LTV policy reduces he vulnerabiliy of banking sysems o propery price shocks. Moreover, morgage defaul risk is esimaed o be less responsive o macroeconomic flucuaions ( 3 ) in economies wih LTV policies han in hose wihou LTV policies ( 4 ). All hings being equal, a 1 percenage poin decrease in GDP growh should raise he delinquency raio by 3 basis poins in economies wih LTV policies compared wih 5.1 basis poins in hose wihou LTV policies. The saisical resuls for he Wald es, however, sugges ha he difference is no significan saisically. The esimaion resuls for Model B are similar o hose for Model A. In addiion, he esimaed coefficiens 1 and 3 are found o be saisically insignifican, suggesing ha MIPs have no reduced he effeciveness of LTV policy. 19 In panel daases, variance in cross-secional unis may be significanly differen. The OLS esimaion is saisically inefficien and can give misleading inference when variances in he daa are unequal. BIS Papers No

10 Table 1 Descripive saisics for unbalanced panel daa for 13 economies Change in morgage delinquency raio In per cen Real propery price growh In per cen Deb-o-GDP raio In per cen Real GDP growh In per cen Change in real ineres raes In per cen Economies Mean Sd dev Mean Sd dev Mean Sd dev Mean Sd dev Mean Sd dev Period Ausralia Canada Greece Hong Kong SAR Korea Malaysia Philippines Porugal Singapore Spain Thailand Unied Kingdom Unied Saes All economies Noe: Sd dev denoes sandard deviaion BIS Papers No 57

11 Table 2 Esimaion resuls for Model A (equaion 1) and Model B (equaion 2) Dependen variable: Change in morgage delinquency raio ( MD ) Model A Model B Consan ( 0 ) ** ** P wih LTV policy ( 1 ) * ** wihou LTV policy ( 2 ) ** ** Incremenal effec of MIP ( 1 ) GDP wih LTV policy ( 3 ) ** * wihou LTV policy ( 4 ) ** ** Incremenal effec of MIP ( 3 ) DTGDP ( 5 ) ** ** In ) ( 6 Adjused R-squared Null hypohesis for he Wald es Chi-square saisics (P-value) Chi-square saisics (P-value) * (0.065) (0.443) Noe: ** and * denoe he 5% and 10% levels of significance, respecively ** (0.026) (0.960) A simulaion exercise To furher visualise he effec of LTV policy on banking sabiliy, we conduc a simulaion exercise for Hong Kong s banking secor in which we esimae he degree o which relaxing he maximum 70% LTV raio for propery lending migh generae losses in he banking secor in he wake of a severe propery price shock. To his end, we consider a hypoheical scenario in which he 70% LTV policy was abandoned some ime before We also assume ha all banks aggressively exploied his policy change, expanding heir business by exending morgage loans ha covered 90% of he value of a propery (ie wih an average LTV raio of 90%). We hen assume a 40% drop in real propery prices. 20 Wih he assumed 20 The shock is comparable o one ha occurred in Hong Kong beween Q and Q BIS Papers No

12 shock, we simulae he movemen of oher variables (ie GDP, In and DTGDP) based on heir hisorical relaionships. 21 Togeher wih he esimaed coefficiens 2, 4, 5 and 6 in Model A, we compue he overall impac of he shock on he delinquency raio. We repea he process 100,000 imes o generae a disribuion of he delinquency raio. For comparison, anoher disribuion ha assumes an iniial LTV raio of 70% is also simulaed. The disribuion is simulaed based on he esimaed coefficiens 1, 3, 5 and 6 in Model A. These wo simulaed disribuions are shown in Graph 3. We find ha if he 70% guideline had been relaxed before 1997, he delinquency raio would have increased from 0.6% o 1.71% (a he 95% confidence level) afer he 40% decline in propery prices. In conras, wih he 70% LTV policy in place, he delinquency raio would have increased only moderaely, o 1.11%. This resul is largely consisen wih he empirical findings of Wong e al (2004). Based on he volume of RML and oal capial in Hong Kong s banking secor in 1997, we compue he credi losses based on he simulaion resuls (Table 3). The calculaion of credi losses akes ino accoun he effec of he drop in propery prices on he loss given defaul. Based on he ail risk, we find ha, if he maximum LTV raio is increased o 90%, he credi loss would come o abou 1.87% of oal capial (a he 95% confidence level), compared wih 0.46% for he acual maximum LTV raio of 70%. Graph 3 Simulaed disribuion of he morgage delinquency raio for Hong Kong 9,000 8,000 7,000 6,000 Maximum LTV raio of 70% Maximum LTV raio of 90% Frequency 5,000 4,000 3,000 2,000 1,000 Source: Auhors esimaes Morgage delinquency raio (%) 21 We follow he simulaion mehod adoped by Wong e al (2008). The model consiss of a seemingly unrelaed regression for he GDP growh rae, ineres raes and real propery prices. For he variable DTGDP, he value is simulaed based on he simulaed GDP growh rae and an iniial value of 50% of DTGDP. 174 BIS Papers No 57

13 Table 3 Simulaed credi losses wih maximum LTV raios of 70% and 90% In millions of Hong Kong dollars As a percenage of oal capial As a percenage of Tier 1 capial Saisics LTV 70% LTV 90% LTV 70% LTV 90% LTV 70% LTV 90% Mean h percenile h percenile h percenile h percenile Noe: LTV 70% refers o he acual policy capping he maximum raio a 70%, whereas LTV 90% refers o he hypoheical maximum raio of 90%. BIS Papers No

14 Annex B: Hisory of Hong Kong s LTV policy Year Major developmens Before 1991 "Residenial morgage" was defined in he Third Schedule of he Banking Ordinance as a morgage where, among oher hings, "he principal sum does no exceed 90% of he purchase price or he marke value of he propery, whichever amoun is he lower" The maximum LTV raio of 70% was adoped by he banking indusry in November 1991 and has since been fully endorsed by he Commissioner of Banking as a prudenial measure agains overexposure o he propery marke. See A guideline was inroduced a he beginning of 1994 when propery lending was rising rapidly. I advised AIs whose exposure o propery markes exceeded 40% of heir loans o local borrowers (he average for he indusry as a whole) ha hey should seek o sabilise or reduce ha percenage. See The Hong Kong Governmen confirmed a a Legislaive Council meeing ha he maximum 70% LTV raio should be adoped as a long-erm regulaory policy. See The HKMA recommended ha a maximum LTV of 60% should be adoped for luxury properies wih a value of more han HK$ 12 million. See AIs were required o have a clearly defined and documened policy wih respec o assessing he abiliy of residenial morgage borrowers o repay heir loans, including a deb servicing raio es. The deb servicing raio, defined as he monhly repaymen obligaions of he borrower as a percenage of monhly income, was se a 50 60% (he upper end of he range was confined o high-income households). See The 40% guideline for AIs was abandoned. See While he HKMA believed ha he 70% LTV guideline remained generally appropriae as a long-erm prudenial measure, and he guideline coninued o be applied o new RML, he HKMA did no objec if AIs chose o depar from he 70% LTV guideline when refinancing he morgage loans of borrowers wih negaive equiy, so long as such loans did no exceed 100% of he curren marke value of he morgaged propery. The 60% LTV guideline for he purchase of luxury properies wih a value of more han HK$ 12 million was abandoned and he maximum LTV raio for such loans was resored o 70%. See Oc 2009 AIs were required o reduce he maximum LTV raio for properies wih a value of HK$ 20 million or more from 70% o 60%. See BIS Papers No 57

15 Year Aug 2010 Nov 2010 Major developmens (con) The HKMA implemened addiional prudenial measures for RML, as follows: Applying a maximum LTV raio of 60% o properies wih a value of a leas HK$ 12 million. For properies valued below $12 million, he 70% LTV guideline coninued o apply, bu he maximum loan amoun was capped a HK$ 7.2 million; Requiring banks o ask morgage applicans wheher hey inended o occupy he morgage propery and lowering he maximum LTV raio o 60% for non-owneroccupied properies; and Reducing he 50 60% range for he deb servicing raio of morgage applicans o 50%. Requiring banks o sress-es morgage applicans' repaymen abiliy assuming an increase in ineres raes of a leas wo percenage poins, and capping sressed deb servicing raios a 60%. See To srenghen risk managemen in RML, he HKMA implemened he following measures: Lowering he maximum LTV raio for properies wih a value of a leas HK$ 12 million from 60% o 50%; Lowering he maximum LTV raio for residenial properies wih a value beween HK$ 8 million and HK$ 12 million from 70% o 60%, and capping he maximum loan amoun a HK$ 6 million; Mainaining he 70% maximum LTV raio for residenial properies wih a value below HK$ 8 million, bu capping he maximum loan amoun a HK$ 4.8 million; and Lowering he maximum LTV raio for all non-owner-occupied residenial properies, properies held by a company, and indusrial and commercial properies o 50%, regardless of he value of said properies. See BIS Papers No

16 References Bank of England (2009): The role of macroprudenial policy: a discussion paper, Bank for Inernaional Selemens (2010): 80h Annual Repor, June. Borio, C, C Furfine and P Lowe (2001): Procyclicaliy of he financial sysem and financial sabiliy: issues and policy opions, in Marrying he macro- and microprudenial dimensions of financial sabiliy, BIS Papers, no 1, pp 1 57, March. Caruana, J (2010a): Sysemic risk: how o deal wih i?, Bank for Inernaional Selemens, 12 February, (2010b): Macroprudenial policy: working owards a new consensus, remarks delivered a he High-Level Meeing on he Emerging Framework for Financial Regulaion and Moneary Policy, joinly sponsored by he BIS s Financial Sabiliy Insiue and he IMF Insiue, Washingon, 23 April. Commissioner of Banking (1991): Annual Repor, Hong Kong. Commissioner of Banking (1992): Annual Repor, Hong Kong. Financial Services Auhoriy of he Unied Kingdom (2009): Morgage marke review, Discussion Papers, no DP09/3, Ocober. Gerlach, S and W Peng (2005): Bank lending and propery prices in Hong Kong, Journal of Banking and Finance, vol 29, no 2, pp , February. Jordan, T (2010): A changing role for cenral banks?, speech delivered by he Vice Chairman of he Governing Board of he Swiss Naional Bank a he Welcome Even Maser of Banking and Finance, S Gallen, 22 Sepember Norges Bank (2010): "Finansilsyne's new guidelines for pruden lending effecs on household deb", Financial Sabiliy Repor, no. 2/2010. Magyar Nemzei Bank (2010): Repor on Financial Sabiliy, April. Papademos, L (2010): The role of macro-prudenial oversigh and moneary policy, speech delivered by he Vice Presiden of he European Cenral Bank a he conference on Crisis in he Global Economy: Re-Planning he Journey, sponsored by he Ponifical Academy of Social Sciences, Vaican Ciy, 3 May, Srauss-Kahn, D (2010): Macro-prudenial policies an Asian perspecive, closing remarks delivered by he Managing Direcor of he Inernaional Moneary Fund a a conference hosed by he People s Bank of China and sponsored by he IMF, Shangha 18 Ocober, Swedish Financial Supervisory Auhoriy (2010): Morgages capped a 85 percen as of 1 Ocober, 9 July. Wong, J, K-F Choi and T Fong (2008): A framework for sress esing banks credi risk, Journal of Risk Model Validaion, vol 2, no 1, pp 3 23, Spring. Wong, J, L Fung, T Fong and A Sze (2004): Residenial morgage risk and loan-o-value raio, Hong Kong Moneary Auhoriy Quarerly Bullein, December. 178 BIS Papers No 57