Meginmál

Why are there rules about maximum loans?

The purpose of setting rules on how large a loan can be taken out, such as for housing purchases, is, among other things, to counter excessive consumer indebtedness and strengthen the resilience of both borrowers and lenders, i.e. the banks, against a potential turnaround in real estate prices. Excessive indebtedness can be risky for both individual parties and the economy as a whole and can thus contribute to instability in the financial system.

Rules have therefore been set regarding the maximum loan-to-value ratio for a home purchase. Rules have also been set regarding how large a portion of net wages can be used to pay off loans for housing purchases. The general rule is that a secured loan for a home purchase may not exceed 80% of the market value of the property (85% for first-time buyers). The debt service burden in proportion to net disposable income may not exceed 35% (40% for first-time buyers).

The purpose of the rules is to preserve financial stability.

What are the capital requirements for financial institutions?

  • Capital requirements are an example of rules that are intended to promote financial stability.
  • There are requirements that financial undertakings have capital in excess of liabilities; in other words, a requirement that total assets minus liabilities be a positive number.
  • The larger the proportion of capital on the balance sheet, the less likely a financial institution will be to default if problems arise.
  • By law, banks and other financial undertakings are subject to higher requirements than companies in general regarding the amount and structure of their capital.
  • The purpose of the minimum capital requirement for banks and other financial undertakings is to ensure the interests of the public and the stability of the financial system as a whole.

What are liquidity requirements for financial undertakings?

  • The objective of liquidity requirements is to reduce the liquidity risk of financial undertakings by ensuring that they always have liquid funds to meet their obligations under stress conditions over a given period.
  • Thus, credit institutions are required to have readily available and sound liquid assets, not only to be able to meet obligations when they fall due, but also to respond to possible outflows that may occur, for example, due to deposit withdrawals, reduced funding opportunities for credit institutions or increased collateral requirements or other things that require a credit institution to spend money under stress conditions over the next 30 days.