The Reserve Bank has called out “potential risks” in the investment property market and warned that macroprudential policies aimed at managing those risks had limited power to curtail speculation.
The RBA also said conceded that the lending restrictions imposed on the banks are “constraining” households but are moderating house price growth.
In its semi-annual health check of the financial system, the central bank also appeared to back tough new accountability measures imposed on bank executives, and highlighted non-bank lenders as a risk area to watch.
The Financial Stability Review, published on Friday, comes six months after the Australian Prudential Regulation Authority imposed lending restrictions on the banks to curb the growth of interest-only mortgages.
The RBA said there “significant declines” in these areas, which had been accompanied by “some moderation in housing conditions”.
But it said tighter credit and higher interest rates on these types of loans would “constrain households and developers”.
Households, it said, won’t be able to get as large a loan as previously while others will find it harder to get financing for off the plan apartment purchases.
“Some borrowers, including investors, could experience increased financial stress as a result of higher repayments from either switching to a principal and interest loan, or higher interest rates if they retain an interest only loan.”
In previous reviews, the bank has taken comfort that 17 per cent of loans are 2 ½ years ahead in prepayments but in April it expressed concern that this statistic “masks substantial variations” and that one third of borrowers had less than one month of buffers.
The bank expanded on this point stating that some of these borrowers were on fixed rate loans or were investors so were not necessarily vulnerable.
“This leaves a smaller share of potentially vulnerable borrowers with new mortgages who have yet to accumulate prepayments, and borrowers who may not be able to afford prepayments.”
Rise in investors with multiple properties
The Reserve Bank took a closer look at investment property owners using Tax Office data and found “potential risks” in the form of lower-income households running up losses on their properties to take advantage of negative gearing, a rise in borrowers with multiple properties, and an increase in indebted investors over 60 years old.
The number of investors with five properties grew by 7.5 per cent in one year versus the 4.5 per cent average over nine years.
“Given the strong growth in investor housing credit and riskier types of borrowing over this period, investors with multiple properties have likely contributed to higher risk.”
Meanwhile, the share of borrowers over 60 has doubled from over 10 per cent to over 20 per cent in a decade, and the share of geared investors in this age group was gone from less than a quarter to around a half.
The RBA conducted detailed analysis of the housing markets in Norway, Canada and New Zealand that have also experienced sharp rises in prices and household debt levels.
Authorities in these countries had also resorted to “macro-prudential” measures aimed at managing financial stability risks.
While the measures appeared to work to some degree, the RBA said it was “difficult to assess” their effectiveness, and that the impacts tend to “diminish over time”
In some regions, house price growth and debt levels “continue to grow rapidly” so risks persist”
Macro-prudential policies, it said “can at best moderate the growth of credit and prices for a while but they cannot address the high levels of debt and prices”.
‘Lapses in risk controls’
The Reserve Bank also made specific reference to bank culture, and “lapses in risk controls” in the wake of the AUSTRAC money laundering debacle at Commonwealth Bank.
In the current environment where investors still expect high rates of return, despite regulatory and other changes that have reduced bank [return on equity], banks need to be careful of taking on more risk to boost returns.”
The RBA appeared to give the Banking Executive Accountability Regime its blessing. The controversial new powers are set to be legislated after being announced in this year’s federal budget.
BEAR, it said, “strengthens APRA’s abilities” to impose civil penalties and dismiss bank executives for poor conduct”.
The Reserve Bank also identified the non-bank lending sector as an “area to watch” as tighter lending restrictions on banks pushes more activity into the un-regulated sector.
It said activity in the sector “had increased relatively strongly” over the last year but did not offset the pull-back by the large banks.
The bank also revealed that it was refining its “top down” bank stress testing models and found that while bank capital levels were resilient to ‘less severe downturns’, their positions weakened substantially once they had cut their dividends, and depleted their retained earnings.
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