Loan‐to‐value limits as a macroprudential policy tool: Developments in theory and practice

Abstract

AbstractI analyze the development of the loan‐to‐value (LTV) ratio limit for households as a macroprudential policy tool in both theory and practice, by surveying theoretical and empirical literature. I argue that the practical implementation of LTV caps preceded theoretical studies, but research has caught up since the global financial crisis, including research on which indicators seem to work best in flagging a potential future crisis. In practice, LTV ratio limits tend to be effective tools in buffering credit and house price growth, although attributing casual effects in empirical studies is not always straightforward. The benefits of LTV policy seem to outweigh some potential side‐effects, such as the output costs of tightening credit. I then survey the recent success with LTV policy in New Zealand and Ireland, particularly by targeting the riskier borrowers. Their experience reveals that learning and fine‐tuning of LTV policies along the way are inevitable.