It’s time to consolidate the house against future shocks
Regulators and banks are responsible for ensuring the stability of the financial system and the economy.
A few months ago, when Sydney and Melbourne entered pandemic containment, there was too much uncertainty about the economy and the housing market for regulators to seriously consider intervening.
There was talk of a possible double dip recession and massive job losses.
This is a different scenario from 2014 to 2018, when APRA imposed restrictions on lending to rampant investors.
But now that the economies of New South Wales and the Victorian era are set to reopen, house prices are skyrocketing and a likely reopening of international borders is expected to increase demand for migrant housing. back, the downside risks have dissipated.
Regulators have less reason to be cautious and to wait.
Nonetheless, this is a different scenario between 2014 and 2018, when APRA imposed restrictions on investor lending and interest-only lending.
At the time, bank credit quality standards had deteriorated and posed risks to the economy and the financial system.
Today, regulators believe that banks have maintained prudent lending standards.
Investor loans recently overtook first-time homebuyers, after first-time homebuyers saw solid growth last year. But investor loans are not out of control.
In the short term, regulators and banks don’t think the mortgage market is risky.
On the contrary, regulators want to insure against potential medium-term shocks, such as rising interest rates or a recession.
Households are more vulnerable to a future shock.
More and more customers are borrowing closer to their maximum limit. The risk is that with more people preparing their balance sheets, a future shock could be amplified by high real estate debt.
If a downturn occurred and workers lost their jobs or working hours, financially troubled households would cut spending. This would further hurt businesses, incomes and jobs, deepening a future recession.
The RBA says it doesn’t expect interest rates to rise until 2024, until inflation is durably within the target range of 2-3%.
However, the recent rise in global inflation, energy price shocks and rising bond yields underscore how uncertain the path of future borrowing costs is.
Many homebuyers who have borrowed at fixed mortgage rates below 2% will face higher rates in three or four years.
Commercial banks will pay higher refinancing costs to replace super-cheap 0.1% loans from the RBA’s three-year financing facility.
To better understand the APRA framework, a speech by APRA President Wayne Byres at the Australian Financial Review Banking Summit in March is instructive.
Byres outlined four mortgage credit risks that APRA was monitoring.
Three of these risks have barely changed from previous trends; investor loans, interest-only loans and high-value loans. They are relatively low and stable.
The only measure of risk that has accelerated is that of loans with high debt-to-income ratios.
New residential mortgages where debt is at least six times greater than income jumped to a record 22% in the June quarter, from 16% a year earlier.
Since interest rates are very low, people can afford to borrow more.
Housing credit increases by about 7 percent and could reach 10 percent with new housing commitments, about double the growth in household income.
RBA Governor Philip Lowe said he would be worried if housing credit grew faster than income for an extended period, especially because household debt is already high.
Ideally, the banks would act on this point without regulatory intervention.
But they face a classic “prisoner’s dilemma” and a competitive disadvantage in moving first.
The Commonwealth Bank of Australia voluntarily raised the interest rate floor to 5.25 per cent from 5.1 per cent in June to gauge people’s ability to repay their loans if interest rates rise. But other banks did not follow suit.
As one senior banker puts it, banks usually go to the limit of regulation and are not inclined to lose customers to their competitors.
ANZ and Westpac have come under pressure from shareholders for losing mortgage market share, in part because their technology and mortgage processing processes are slower than those of the CBA.
Therefore, recent subtle market warnings by the RBA and APRA about the risks of debt distress in a world of low interest rates have had little effect.
Ultimately, bankers would prefer regulators to set consistent rules for home loans, instead of taking the lead.
ABC’s Matt Comyn has indicated that he would prefer small and early measures, to avoid the risks of festering for too long that may require more drastic interventions later.
The last time APRA cracked down on investor and interest-only loans, house prices in Sydney fell by around 15% and Melbourne fell by 10%.
APRA designed a safe landing. But declining household wealth has caused consumers to cut spending on discretionary items such as cars and furniture more than the RBA expected.
As a federal election approaches, tightening debt-to-income rules to guard against future shocks will require a great deal of skill.