The Reserve Bank has confirmed that it is discussing policies that might limit risky lending to housing investors.

In its latest half-yearly Financial Stability Review the RBA has expressed concerns that more housing investors are entering the market than is warranted by rental demand.

"As a result, the composition of housing and mortgage markets is becoming unbalanced, with new lending to investors being out of proportion to rental housing's share of the housing stock," the bank noted.

Investor lending is now making up over 40 per cent of the value of new loans nationally, and significantly more in the investment hotspots of Sydney and Melbourne.

Investor home loan approvals have almost doubled in New South Wales over the past two years, and are up 50 per cent in Victoria.

At the same time, the proportion of loans going to first home buyers is at record lows and owner-occupier credit growth remains relatively subdued.

The Reserve Bank is now worried that many investors are buying into these markets solely on the expectation of continued home price growth, rather than on the rents they are likely to receive.

It is concerned that this "additional speculative demand can amplify the property price cycle and increase the potential for prices to fall later."

Lending standards questioned

While it acknowledges that average bank lending standards do not appear to have eased, the RBA has questioned whether the previous standards are still appropriate.

"A crucial question for both macroeconomic and financial stability is whether lending practices across the banking industry are conservative enough for the current combination of low interest rates, strong housing price growth and higher household indebtedness than in past decades," the bank observed.

It is a question the Reserve Bank has raised with the banking watchdog APRA (the Australian Prudential Regulation Authority) and other regulators.

APRA has already communicated with banks asking them to curtail very high loan-to-value-ratio (LVR) lending and to maintain conservative standards regarding property valuations and tests on borrower’s abilities to service their loans with higher interest rates.

However, the RBA has noted that while the number of loans with very high LVRs of over 90 per cent has recently fallen, investor loans with LVRs between 80 and 90 per cent have been on the rise.

It has also expressed concern about a rising number of interest only loans, and higher average loan sizes relative to incomes.

The Reserve Bank says interest only loans present a number of dangers to borrowers.

"If the loan balance is not declining via principal repayment, it is more likely that it will exceed the property value (be in negative equity) if housing prices should fall," the RBA warned.

"There is also a risk that the borrower could face difficulty servicing the higher (principal and interest) repayments after the interest-only period ends."

'Further steps' to enforce lending standards

To counter these threats, the Reserve Bank has confirmed that it is discussing with APRA and the other members of the Council of Financial Regulators "further steps that might be taken to reinforce sound lending practices, particularly for lending to investors."

This sounds like code for the type of so-called macroprudential policies undertaken in many countries, including New Zealand and the UK, which put regulatory limits on certain types of lending.

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In New Zealand the rules limit the proportion of high LVR loans banks can make; in the UK the regulations enforce stricter loan-to-income tests.

Many analysts, and a growing number of international financial institutions (including the IMF), have been advocating the use of such rules however, to date, the RBA has been lukewarm.

The latest comments from the bank indicate that there are likely to be at least informal, if not formal, rules imposed by APRA on bank lending standards to property investors.

The tone of the bank's commentary suggests that these may involve stricter loan-to-income and/or LVR testing for investors, especially if they are taking out an interest-only loan.