The effectiveness of the counter-cyclical loan-to-value regulation: Generic versus sector-specific rules

Abstract

This paper considers the implications of the counter-cyclical loan-to-value (CcLTV) regulation in a setting where different types of borrowers from distinct sectors of the credit market co-exist. We consider two macro-prudential policy regimes, namely generic and sector-specific. We find that both regimes are more effective than the baseline regime (constant LTV ratios) in stabilising macroeconomic and financial stability, and welfare enhancing. Compared to the generic regime, the sector-specific regime delivers a higher degree of macroeconomic and financial stability. For both regimes there is a clear tradeoff between financial and macroeconomic stability, as the authority adjusts its preference between the two policy objectives. To enhance the effectiveness of the CcLTV regulation, we argue that the regulator should consider borrowers’ heterogeneity, and tailor the regulation according to the specific conditions of each sector of the credit market, rather than to the aggregate credit conditions.