'Our economy will suffer': Philip Lowe is concerned lending standards in Australia have become too strict

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  • Australia’s housing market has undergone a major shift over the past 18 months with prices, new lending, and building approvals all starting to fall at varying speeds.
  • A big factor behind this reversal has been a tightening in lending standards.
  • In a speech delivered on Tuesday, RBA Governor Philip Lowe said he was becoming “a bit concerned” that lending standards are becoming too restrictive, warning that the “economy will suffer” should current caution from lenders persist.
  • Australia’s Banking Royal Commission won’t deliver its final report until early next year, making it difficult to loosen lending standards given the poor conduct that has been uncovered across the industry.

Australia’s housing market has undergone a major shift over the past 18 months with prices, new lending, building approvals all starting to fall at varying speeds.

It’s quite the contrast to what was seen in prior years when the housing market was booming in Australia’s southeastern corner.

The turnaround in market conditions, quite stark in Sydney and Melbourne, has coincided with stability in the RBA cash rate, out-of-cycle mortgage rate increases and a tightening in lending standards.

The latter, in particular, has had a pronounced effect on the housing market, leading to a sharp plunge in credit growth to investors and, more recently, that extended to owner-occupiers.

Beginning in late 2014, tighter lending standards to limit investor credit growth to 10% per annum has morphed into restricting interest-only loans to 30% of all new mortgages to curbing lending to heavily indebted borrowers, leading to the slowdown in credit growth seen today.

Coupled with weaker offshore demand for Aussie property, that’s seen prices fall in those markets that were previously hotbeds for investor activity, and has undoubtedly contributed to the steep falls in new apartment approvals and sales and demand for residential construction workers.

To date, most economic indicators suggest the credit-led downturn in the property market has not spilled over into the broader Australian economy.

However, in a sign that policymakers are becoming increasingly uncomfortable that it may, Reserve Bank of Australia (RBA) Governor Philip Lowe says he’s now become “concerned” that after years of being too relaxed, lending standards may now have swung too far, too quickly in the opposite direction.

“A few years ago credit standards were way too loose, there has been a correction of that, but I am starting to be a bit concerned the pendulum might be swinging a bit too far the other way,” Lowe told the annual CEDA dinner in Melbourne on Tuesday.

“I am hoping in time it will come back to the centre, so we are watching the ability of financial institutions to grow credit very carefully.”

“Very carefully” — not the kind of remark that suggests the bank is comfortable with the current state of affairs.

Lowe told the audience that “a balance needs to be struck here”.

“Even when banks lend responsibly, a percentage of borrowers will end up in financial strife and be unable to meet their obligations,” he said.

“We need banks to be prepared to make loans in the full expectation that some borrowers will not be able to pay them back. Banks need to take risk and manage that risk well.

“If they become afraid to lend simply because of the consequences of making a loan that goes bad, our economy will suffer.”

Royal Commission in play

As a member of Australia’s Council of Financial Regulators (CFR) who initiated the push towards tighter lending standards to reduce financial stability risks, Lowe’s remarks suggests this process may now be contributing to additional risks of its own.

On any other occasion, it would also suggest that a change in macroprudential restrictions to govern lending standards could be in the offing.

However, there’s just one small problem that may prevent any near-term tweak to lending standards: Australia’s Banking Royal Commission, providing a near year-long insight to the poor practices of Australian financial firms.

With the RBA clearly reluctant to cut official interest rates further, it wouldn’t be a great look if the Council of Financial Regulators suddenly decided there were grounds to slightly relax lending restrictions to help keep the credit taps flowing ahead of the Commission’s final report that will be delivered early next year.

It’s a tricky situation, potentially seeing risks from a spillover into the broader economy from continued weakness in the housing market grow in the months ahead.

Before the Royal Commission delivers its final report, including recommendations on conduct, Lowe delivered a simple message to the bank’s on how to best support the economy in the interim:

“[Trust] is more likely to be maximised if our financial institutions have a long-term perspective, treat their customers well, reward loyalty rather than take advantage of it, and invest in systems and technology that deliver world-class financial services for Australians,” he said.

“Doing this would not only be good for bank shareholders, but also for the broader community.”

The Banking Royal Commission report must be submitted by February 1, 2019.

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