One of the strangest things about APRA and the RBA’s approach to reining in rampant investor lending in 2015 was the 10% growth cap on investor loans appeared to be arbitrary. It left investor loans growing at a much stronger pace than the rate of nominal economic growth.
But in a speech today Luci Ellis, the RBA’s head of financial stability, used a neat analogy about food, debt, nutrition, and obesity to explain why the cap was never meant to close off investor lending altogether and certainly was meant to leave owner-occupier loans unaffected.
Ellis said what is important in credit growth is to continue availability, while still trying to slow rampant growth. So APRA’s 10% cap was still below the prevailing growth rates in 2014 and 2015, not the actual level itself.
As the RBA said, and APRA implied, the rate of investor lending growth before the 10% cap was driving prices sharply higher and posed macroeconomic risks to the broader economy if it led to a bubble that burst.
The policy worked, and the growth rate and total monthly volume of investor lending slipped back to still-high levels, but ones Ellis implied the RBA and APRA are more comfortable with.
Explaining that notion Ellis said credit creation is like obesity.
“We know that excess weight can in certain circumstances be dangerous to our health, and excess debt can be dangerous for our wealth. But the solution to obesity is not to stop eating completely. In fact, eating too little can be far more damaging than eating a bit too much. Likewise, financial stability is not best pursued by banishing debt altogether,” Ellis said (our emphasis).
Extending the analogy between eating and borrowing, she said there is no “obvious bright line between what is safe and what is disastrous”.
As a result “policymakers should seek to control the risks posed by credit growth, not to prevent all episodes of strong credit growth. That would be like trying to ban date nights and Christmas dinners, when what you really want to do is reduce ill health”.
The problem with this debt and obesity analogy, Ellis said, is that what might be true for an individual is much harder to know on a population-wide basis.
She said “economics has not, unfortunately, provided us with much of a clue about safe debt levels across a whole economy. And that is precisely because knowing what works for an individual doesn’t help much at the national level”.
Which gets us back to the 10% cap on investor lending.
Unlike the RBNZ, which has much more proscriptive limits on LVR’s and deposits in the Auckland housing market, APRA focused on limiting investor lending.
Ellis said the distribution of debt is important and “one borrower might well have taken on too much debt, but the solution is not to deprive someone else of finance that they can reasonably handle”.
So restricting one class of borrowers, who the RBA and APRA clear saw as stretched in aggregate, while not impacting on owner-occupiers, was their favoured approach.
Now I understand. I think. It’s all about a balanced diet.