As someone with over two decades of experience in banking, witnessing the evolution of credit risk policies, I find myself reflecting on the resurgence of Debt to Income (DTI) ratios in the financial landscape. Having observed the shift away from DTI towards Uncommitted Monthly Income (UMI) assessments, the recent move by the Reserve Bank of New Zealand (RBNZ) to introduce DTI requirements for registered banks has sparked my contemplation.
In the early 2000s, DTI was a common policy rule among UK banks, with limits set based on joint or single household income. Over the years, DTI faded as Uncommitted Monthly Income (UMI) took the spotlight. UMI, a more nuanced measure, considers not just income but also the expenses and discretionary spending commitments of households. It became a key metric in loan assessments, providing a more holistic view of a borrower's capacity.
My skepticism towards DTI as a measure of customer capacity stems from its exclusive focus on income without considering household expenses. Ignoring expenses makes DTI inadvertently biased towards high-income earners, potentially impacting younger, first-time homeowners at the early stages of their careers. The inclusion and exclusion criteria in DTI assessments pose challenges. The RBNZ's current consultation considers debt linked to residential mortgages as part of the DTI calculation. This may inadvertently affect small businesses, as banks often secure business loans with personal guarantees tied to the owner's residential property. Amid challenging times for small businesses, DTI could unintentionally restrict lending, impacting their survival.
Contrasting this with UMI, which evaluates uncommitted income, provides a more nuanced understanding of financial capacity. New Zealand banks have spent the last three years implementing UMI changes to comply with responsible lending requirements. UMI considers a reasonable surplus and incorporates a hurdle rate for potential mortgage interest rate increases, offering a comprehensive view of a borrower's capacity.
Introducing DTI as a new compliance obligation raises questions about its necessity when responsible lending requirements are already in place. Additional restrictions may lead to unintended consequences and distortions in the flow of money and liquidity, potentially hindering economic growth.
While I expect DTI to be implemented, particularly as the RBNZ seeks to control the housing cycle as they start to reduce the OCR later this year, concerns arise regarding its potential impact on lending dynamics. Higher income earners and investors with multiple income streams may benefit, causing a shift in new lending patterns. The implications for small businesses are uncertain, with potential challenges in accessing working capital.
As the implementation unfolds, I anticipate closely monitoring the reporting from the RBNZ over the next few years. The repercussions, especially on first-time buyers and SMEs, will be telling. Will lending to businesses face hurdles, or will banks adapt their practices to accommodate the changing landscape?
In navigating these shifts, I remain intrigued and watchful, recognising that time will reveal the true impact of these policy changes on the financial landscape. The delicate balance between prudent risk management and facilitating economic growth will be a narrative to follow in the evolving credit risk landscape.