The Sydney property market has been booming for well over a year now. Melbourne is doing well too. But the market around the rest of the country is just ambling along.
Even though the boom is narrowly focused a Freedom of Information release from the RBA this week showed just how concerned the central bank is about house prices. The RBA, like many concerned about the concentration of investor buying and its potential impact in an economic downturn, recognises any effect of falling house prices “is likely to be spread across a broader range of households than the investors that contributed to the heightened activity.”
That’s led to increased demand for “macro-prudential” restrictions by the banking regulator, APRA, on what, who, and how much Australian banks, building societies, and credit unions can lend to property buyers.
So far APRA and the RBA have not signalled enthusiasm to walk down the macro-prudential path followed by the Reserve Bank of New Zealand.
But there is an under-appreciated reality in the commentary around the housing price surge and the activities of APRA, and to a much lesser extent the RBA, when it comes to regulating banks and their home loan lending.
Not only is APRA increasing overall oversight, tightening up prudential regulations on risk measurement, monitoring and managing, but they’re also dealing with each one of the 100 or so financial institutions it oversees individually. It is doing this with a common theme about the risk around home loan lending.
That’s the message APRA chairman Wayne Byers gave the CEOs and chairs of the customer-owned banking institutions (mutual banks, building societies and credit unions) in his speech in Sydney yesterday.
Up to this point, we have opted to stick with traditional micro-prudential tools targeted at individual ADIs and their specific practices, albeit with an eye to financial stability risks as well as the safety and soundness of individual entities. We are not seeking to determine an appropriate level of house prices, or a particular level of household debt. That is beyond our mandate. Our goal is simpler: reinforcing sound lending standards, which is the ‘bread and butter’ work of a banking supervisor.
It’s also important to note that Byers said house prices are not being targeted.
But that doesn’t mean APRA is sitting still. Byers told his audience that APRA has been concerned about how loans are approved given that an assessment of both income and expenses is fundamental to “a borrower’s ability to service and ultimately to repay a loan without undue hardship, including under periods of economic stress.”
He said that APRA had undertaken “a small hypothetical borrower survey,” where they asked a number of Australia’s larger lenders “to provide their serviceability assessments for four hypothetical borrowers that we invented (two owner-occupiers, and two investors).”
What APRA learnt was these lenders varied in their approach to the assessment of income and expenses with some disquieting results. “Our overall conclusion from this hypothetical borrower exercise was that there were clearly examples of practice that were less than prudent,” Byers said.
That’s an indictment on Australian banking. But Australia, in the modern age, does not have a history of overly large nor problematic home loans losses. RBA research has shown that business loans and commercial losses have been the issue for the banking system through time.
But Byers had this to say about the implications of the lending survey:
Making overly optimistic assessments of a borrower’s capacity to repay does not seem a sensible or sustainable basis on which to attract new customers or retain existing ones. It also runs the risk of adverse selection and an accumulation of higher risk customers who (perhaps quite justifiably) cannot get finance elsewhere. To go back to my opening remarks, it does not fulfil the precondition for long-term success.
As a result of the test Byers said the lenders who are the focus of their concerns, had agreed to change their approach to income and expense assessment.
“ADIs have now had long enough to revise their ambitions where needed, and we will be watching carefully to see a moderation in growth in investor lending in the second half of the year as revised plans are implemented,” he said.
That suggests that if there is no pullback in rampant lending to investors, Australia and APRA will be on the path toward macro-prudential regulations.