The macroeconomic effects of the LTV and LTI ratios in Ireland

ABSTRACT

We use the Central Bank of Ireland’s Dynamic Stochastic General Equilibrium model to investigate the introduction of regulatory loan-to-value and loan-to-income ratios in 2015, which form part of the Central Bank’s macroprudential measures. The main finding is that while the measures dampen economic activity in the short run, they bring benefits in the medium and long run. Household leverage declines, which lowers the default rate on bank loans. Households deleverage and foreign debt decreases significantly.

KEYWORDS:

• Macroprudential policy
• borrower-based measures
• LTI
• LTV

JEL CLASSIFICATION:

• E21
• E32
• E44
• E58
• F41

Acknowledgements

We are grateful to Martin O’Brien, Fergal McCann, Yvonne McCarthy, Gabriel Fagan, Reamonn Lydon, Luca Onorante, Gerard O’Reilly and Conor O’Toole for comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ J.A. Carrasco-Gallego and Rubio (2016) or  Beneš, Laxton, and Mongardini (2016) only investigate how countercyclical adjustments of LTV can be used to stabilize business cycle fluctuations.

² See Equations (12) and (23) in Lozej, Onorante, and Rannenberg (2017).

³ Specifically, .

⁴ corresponds to the term in M. Lozej, Onorante, and Rannenberg (2017).

⁵ See also M. Lozej, Onorante, and Rannenberg (2017).

⁶ The evidence from loan-level data suggests that after the introduction in 2015, the regulation had a more pronounced effect on the LTV distribution than on the LTI distribution of new loans (E. Keenan et al. 2016). This implies that the LTV was constraining household behaviour more than the LTI.

⁷ All data are for in-scope loans for all borrowers, and for 2015, they are after the measures were introduced. The decline in the mean (0.41 p.p.) is not materially different from the median.

⁸ Lower house prices reduce the value of the collateral, which temporarily increases LTV and the default probability.

⁹ The model likely overstates short run costs and understates long run benefits. Because households own nonresidential capital stock, nonresidential investment is directly negatively affected by the measure. Furthermore, the feedback of foreign debt to the risk premium is calibrated to be small, so that benefits from foreign debt reduction are small.

¹⁰ Quantitative, but not qualitative, results depend to some extent on the elasticity of housing. With higher housing elasticity of substitution, long-run results for LTV and LTI are more aligned.