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Higher capital requirements/risk weights
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Danger of pushing lenders in the direction of riskier loans;
With any other measure increasing the cost of bank credit (when credit is in high demand), procyclical risk weights may be circumvented through recourse to non- bank intermediaries, foreign banks, and o -balance-sheet activities;
Will lose effectiveness when actual bank capital ratios are well in excess of regula- tory minima (as often happens during booms);
While improving the resilience of the banking system to busts, tighter require- ments are unlikely to have a major e ect on credit availability and prices;
May be reluctant to allow banks to reduce risk weights during a bust (when borrow- ers become less creditworthy).
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The empirical evidence on the effec- tiveness of these measures is mixed. Several countries have raised capital requirements and/or risk weights on particular groups of real estate loans. Some attempts (such as the cases of Bulgaria, Croatia, Estonia, and Ukraine) failed to stop the boom; others (such as the case of Poland) were at least a partial success.
Even in countries where tighter capital requirements appeared to produce some results on controlling the growth of particular groups of loans, real estate price appreciation and the overall credit growth remained strong.
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Dynamic provisioning
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Is not meant to have a significant impact on credit and contain other vulner- abilities associated with a boom, such
as increases in debt and leverage in the household sector.
Practical issues and unintended effects such as calibration of rules with rather demanding data requirements and earn- ings management (which may raise issues with tax authorities and securities mar- kets regulators).
Being primarily targeted at commercial banks, dynamic provisioning may be circumvented by intermediaries outside of the regulatory perimeter).
Application of the measure only to domestically regulated banks may hurt their competitiveness and shift lending to banks abroad, raising cross-border super- vision issues.
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The experience with these measures suggests that they are effective in strengthening a banking system against the effects of a bust, but do little to stop the boom itself.
Spain led the countries that have adopted countercyclical provisioning. Starting in 2000 and with a major revision in 2004, the Bank of Spain required banks to accumulate addi- tional provisions based on the “latent loss” in their loan portfolios (for more details on the Spanish dynamic provi- sioning framework, see Saurina 2009). Dynamic provisions forced banks to set aside, on average, the equivalent of 10% of their net operating income. yet, household leverage grew by a still-high 62% in Spain.
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Limits on loan-to-value and debt-to-income ratios
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Careful design of these measures is a key to limit circumvention.
As it has been for monetary policy, calibration of these tools will be a learn- ing process. And a clear communication strategy will need to be developed to improve their e ciency.
Unlike with more “macro” measures, the consequences of these limits are immedi- ate and transparent.
Beyond these political economy consider- ations, LTV and DTI limits, by rationing sensitive groups out of credit markets, will entail a cost in terms of diminished inter temporal consumption smoothing and lower investment e ciency.
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Existing empirical evidence suggests that these are promising measures: – In a simple cross-section of 21
(mostly) developed countries, maxi- mum LTV limits are positively related to house price appreciation between 2000 and 2007. And back-of-the-envelope calculations suggest that a 10 percentage point increase in maximum LTV allowed by regulations is associated with a 13% increase in nominal house prices
Regressions on a panel of the USA from 1978 to 2008 suggest a weaker association with house price ap- preciation of a given LTV: roughly 5% increase in house prices for a 10 percentage point increase in LTV.
When the Korean authorities introduced LTV limits in September 2002, month-on-month change in house prices decreased from 3.4% to 0.3% immediately and remained low until April 2003.
In Hong Kong SAR, prudent lending practices guided by LTV and DTI limits have been credited with pausing the house price boom briefly in 1994 and guarding the system against the fallout from the crash in 1997 (Wong et al. 2004, 2011).
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