The Reserve Bank of Australia (RBA) has outlined its concerns about the risk of excessive borrowing, noting if house prices declined or interest rates increased in the longer term, everyday Australians could be in for a rough ride.
In its half yearly Financial Stability Review report issued last Thursday, the RBA reported Australia’s financial systems generally remained resilient, despite the prolonged impacts of a global pandemic.
They recognised banks had helped cushion the economic impact in a time of uncertainty and supported the recovery through loan deferrals and new lending.
However, with house prices rapidly increasing they stated there was a trend emerging where borrowers had an appetite for increased risk.
“In Australia, there have been large increases in housing prices and an acceleration in borrowing,” the RBA report stated.
“Higher prices have improved the financial resilience of existing indebted borrowers. However, there has been a build-up of systemic risks associated with high and rising household indebtedness.”
The report explained this vulnerability would build further if “housing market strength gives way to exuberance” and expectations of further price increases led buyers to take on greater risk.
The RBA also noted the economy was not yet out of the woods.
“In Australia, the fall in output and hours worked in the September quarter demonstrated that the economic risk from the pandemic persists,” the report stated.
“However, the Australian financial system is highly resilient – with rapid progress in vaccinations, it is expected that output will rebound as the economy gradually reopens, reducing the risk to the financial system.”
Household finances
The RBA said most Australian households had entered the most recent period of lockdowns with strong household finances, and many remained in a solid financial position.
“Most had accumulated substantial liquid asset buffers and continued to meet, or remain ahead of, their debt repayment schedules,” the RBA explained.
That said, people working in some sectors had been more affected by the recent restrictions than others.
“Those in pandemic-affected industries or located in regions that have experienced prolonged lockdowns are more likely to be running down their buffers and some could face debt repayment difficulties,” they continued.
“Despite the significant policy support, it is likely that not all businesses will recover and insolvencies will rise, although this will be from a low level.”
Housing prices
Rising housing prices have been a regular topic of discussion for the RBA over recent months.
In their most recent report, the RBA noted national housing prices were 20 per cent higher over the year to September 2021.
This growth has been supported by low interest rates and the economic recovery that had been underway prior to the recent COVID-19 restrictions.
“These broad-based increases in housing prices have strengthened the balance sheet positions of property owners (around two-thirds of all households), including those with existing mortgages,” the RBA said.
“Almost all borrowers have positive equity in their properties (i.e. the current value of their property exceeds that of their outstanding loan), and so (at current prices) could resolve serious debt repayment difficulties by selling their properties.”
Housing credit
Rising house prices, low interest rates and positive equity have seen housing lending pick up this year, the RBA continued.
“This reflects the strength in the housing market that began in the latter part of 2020 and has been underpinned by low interest rates, targeted policy measures and the economic recovery.”
While lenders have so far maintained sound lending standards, the RBA noted there had been an increase in loans with high debt-to-income (DTI) ratios.
“While there has been a slight moderation in housing turnover and housing price growth as a result of the lockdowns, recent data on commitments suggest housing credit growth is likely to pick up further over the coming months,” they stated.
“A sustained acceleration in housing credit growth would add to risks related to the already-high level of household debt.
“Unsustainable debt trends could emerge in an environment of rapidly rising property prices and extrapolative expectations, with new borrowers stretching their financial capacity and a greater chance of disorderly future price corrections.”
Credit growth
The RBA explained housing credit growth had increased at an annualised rate of 7.5 per cent over the six months to August.
“Higher borrowing has been supported by low interest rates and reflects increased turnover of existing dwellings as well as elevated levels of construction of new houses – the latter boosted by a range of government initiatives,” they said.
“As a share of credit, loan commitments have increased sharply for both owner-occupiers and, more recently, investors.
“If loan commitments were to be maintained around their recent levels, credit growth could be around 10 per cent in six-month-ended annualised terms by early next year.
“This would exceed income growth, pushing aggregate household credit-to-income ratios higher.”
Interest rates
The RBA has widely publicised the fact they will not increase the cash rate until actual inflation is sustainably within the two to three per cent target range.
They have further predicted that will not occur until 2024.
However, they did warn of the risk associated with an interest rate rise in the long-term when it came to household debt.
“While rises in asset prices have been underpinned by low interest rates and expected investment earnings, some asset prices appear high given the pandemic still presents a risk to economic activity,” they said.
“Further, price falls could be widespread if interest rates were to increase sharply due to unexpected inflation or rising risk premiums.
“Sharp price falls could cause greatest harm to the financial system for assets where leverage is common, notably residential and commercial property.”
Lending regulations
The RBA also referenced the introduction of tighter lending conditions in a bid to curb household mortgage debt.
“To address this risk environment, in early October the Australian Prudential Regulation Authority (APRA) increased the serviceability assessment rate it expects lenders to use to assess prospective borrowers, thereby reducing maximum loan sizes,” they said.
“It is important that lending standards are maintained, and that the riskiness of system-wide lending does not increase.”
