Australia’s banking regulator just removed a rule that’s played a crucial part in the housing downturn

  • The Australian banking regulator will remove restrictions on interest-only mortgage lending for some Australian banks from January 1 next year.
  • APRA says macroprudential restrictions have “helped to reduce the risks associated with the high level of household indebtedness, subdued household income growth, low interest rates and strong competitive pressure”.
  • It warned banks to “maintain prudent internal risk limits on interest-only lending”. It said restrictions could be reintroduced if lending standards weaken again.
  • Credit growth to home borrowers has slowed sharply this year, especially to investors. That has contributed to steep falls in Australia’s largest housing markets over the same period.
  • The RBA has previously expressed concern that Australia’s “economy will suffer” should bank’s become “afraid to lend simply because of the consequences of making a loan that goes bad”.

  • Australia’s Banking Regulator, APRA, has announced it will remove restrictions on interest-only mortgage lending for some Australian banks from January 1 next year.

    “In April 2018, APRA announced the removal of the supervisory benchmark on investor loan growth, reflecting the improvements that ADIs have made to lending standards,” said APRA Chairman Wayne Byres in a statement.

    “APRA is now also removing the supervisory benchmark on interest-only lending, for ADIs that have provided assurances on the strength of their standards.”

    Shares in the major banks are rallying, with the ASX financials index up 1% a short time ago compared to a slight fall for the broader index.

    Until today’s announcement, APRA had capped interest-only lending to 30% of all new mortgages since April 2017, adding to the 10% annual cap on investor housing credit growth that had been introduced in late 2014.

    Both have now been removed following a steep deceleration in credit and home loan growth to both cohorts in recent years.

    “APRA’s actions to reinforce sound residential mortgage lending practices in recent years have prompted authorised deposit-taking institutions (ADIs) to improve significantly their lending standards and reduce higher risk lending,” Byres said.

    “This has strengthened, in APRA’s view, both the resilience of individual ADIs and overall financial system stability; it has also helped to reduce the risks associated with the high level of household indebtedness, subdued household income growth, low interest rates and strong competitive pressure.”

    However, while APRA is now satisfied that lending practices have improved, it warned that it will be keeping a close eye on lenders following today’s decision.

    “In APRA’s view, interest-only mortgages, and in particular owner-occupied interest-only lending, remain a higher risk form of lending,” Byres said.

    “As a result, APRA expects that ADIs will maintain prudent internal risk limits on interest-only lending. These internal limits should cover both the level of new interest-only lending and the type, including lending on an interest-only basis to owner-occupiers and lending on an interest-only basis at high LVRs [loan to value ratios].

    “Interest-only periods should be of limited duration, particularly for owner-occupiers, and serviceability assessments should test borrowers’ ability to repay principal and interest over the actual repayment period, excluding the interest-only term.”

    Close monitoring

    Byres announced that APRA will conduct a review of ADI risk controls on interest-only lending next year, as part of a broader assessment of improvements that have been made in lending standards.

    Along with the RBA, ASIC, and Treasury — members of Australia’s Council of Financial Regulators — Byres said APRA will “continue to monitor closely conditions in the housing market more generally”.

    “As with investor loan growth, a re-acceleration in interest-only lending at an industry-wide level would raise systemic concerns. In such a scenario, APRA would consider the need to apply industry-wide measures in response,” he said.

    So the removal of the cap on interest-only lending could be reintroduced or additional restrictions introduced should the lending standards start to weaken.

    Today’s decision follows a series of statements from policymakers at the RBA expressing concern that lending standards had become too strict, increasing the potential for weakness in the housing market to spill over into other parts of the Australian economy.

    Sally Auld, chief economist at J.P. Morgan in Australia, said the “announcement comes amid rising anxiety on the part of the RBA that lending standards have tightened too far.

    “But as APRA made clear, the constraint on IO lending was only meant to be temporary, and banks are still required to lend in a manner consistent with “… ASIC’s responsible lending obligations on borrower requirements and objectives.”

    Auld added: “With lenders yet to feel the full impact of the Royal Commission (the final report is not due until early February) dwelling prices still declining in the major cities, and regulators still focused on loan-to-income ratios and serviceability criteria, it is hard to see – despite the RBA’s desire – much changing in the supply of credit near term.”

    According to separate data from the RBA, Australian housing credit grew by 5.1% in the 12 months to October, the weakest increase in five years.

    In October alone, housing credit grew by just 0.3%, the smallest monthly increase in percentage terms since July 1984.

    Credit extended to owner-occupier borrowers grew by 7% over the year, the slowest expansion since November 2015. Over the same period, credit growth to housing investors stood at just 1.3%, the weakest increase on record.

    In mid-2015, annual credit growth to investors was running as high as 10.8%, helping to explain why APRA moved to cool interest-only lending, that favoured by the vast majority of investors.

    Along with an additional strengthening in lending standards based on household expenses and access to additional credit to already-indebted borrowers, the impact of APRA interest-only restrictions has been most acutely felt in Sydney and Melbourne where property prices have fallen sharply this year, including an acceleration in the pace of price declines over the past month.

    The question now is whether the removal of these restrictions will be be enough to slow or stop price falls in these cities in the first half of 2019?

    Much will depend on the willingness of banks to lend even with less onerous restrictions, along with other factors such as recommendations from Australia’s banking royal commission, the outcome of Australia’s federal election and broader economic conditions in the Australian economy, especially the jobs market.