That said, the RBA is becoming anxious that lending standards have tightened significantly, and that continued credit constriction may add fuel to fire. The Australian newspaper has reported that “Reserve Bank governor Philip Lowe is understood to have met with the big bank chiefs in recent weeks to caution them against an overzealous tightening of credit supply in response to lending rules and the Hayne royal commission”.
The RBA is treading a fine line here given the decades of bad behaviour of the banks exposed in the banking royal commission which has led to tighter lending standards and the epic build-up of debt on household balance sheets from the property binge threatens long term financial stability. But it is important to remember the hit to households and the economy from a housing market crash would be dire. Though, it could be argued the unwind of credit excesses is eventually necessary to press reset on the economy and fix the problems with real change rather than keep inflating asset price bubbles in a bid to “extend-and-pretend” as our Chief Economist, Steen Jakobsen notes.
In fact, just recently, in a bid to extend-and-pretend blowing bubbles Australia’s prudential regulator announced it is removing the 30% limit on interest only lending along with the 10% growth cap on lending to property investors, confirming the financial regulators are concerned about the credit downturn and accelerating falls in property prices. The Australian Prudential Regulation Authority said the restriction had “served its purpose” as the proportion of new interest-only loans has halved since the cap was introduced last year.
The Q3 lending data shows that interest only loans made up 16% of new lending, in 2015 this figure was almost 50%. Following the introduction of the cap, rates for these loans repriced higher, correspondingly the removal should reduce rates. Interest only loans are typically used by investors utilising negative gearing concessions and whilst house prices continue to slide investor demand is weaker and is likely to remain so even if rates on interest only loans come down a touch. However, the move is unlikely to cause a meaningful increase in credit supply as banks will continue to tighten credit standards and serviceability measures in the wake of the banking royal commission.
Tougher credit checks and verification of borrower income and expenses are in full swing, as the Australian Financial Review reports “no application is spared a forensic look at discretionary spending.” The royal commission final report is due to be submitted to the Governor-General by 1 February 2019 and it is highly unlikely credit standards are loosened in the run up to this event.
What would it take for the RBA to get worried?
The risks to the downside would become more severe if unemployment were to rise in the midst of hit to economic growth or in the wake of the Royal Commission banks further tighten lending standards resulting in lower loan supply and higher loan costs. A self-perpetuating feedback loop could then ensue as prices fall further and loan supply is still tight, mortgage stress rises, defaults rise particularly for those with less equity in their homes, vulnerable mortgagees can then no longer afford their mortgages and are forced to sell their homes. As unemployment increases this further perpetuates that vicious circle as those with loss of unemployment are forced to sell sending prices spiralling further down. If this scenario were to unfold the RBA would have no choice but to cut the cash rate and depending on the severity of the slowdown implement quantitative easing as a policy response, another scenario outlined by Debelle in his December speech.
How is the economy holding up?
All eyes are on the household indicators with house prices continuing to fall and consumption accounting for around two-thirds of the economy. As we previously noted, household spending stumbled in the Q3 GDP, weighing on growth. The effect of a sustained fall in the housing market is a key risk to the RBA forecasts and not to be underestimated. The household savings ratio fell to 2.4%, the lowest level since the financial crisis, but this drawdown is failing to support strengthened household consumption. Household spending growth slowed from 0.9% in Q2 to 0.3% against a declining household savings ratio. The risks arise whereby as house prices fall, households may feel less comfortable with running down their savings especially if wages are stagnant, eventually consumption takes a hit. The combination of soft household consumption and negative household income growth per capita is cause for concern against the backdrop of a cooling housing market, tighter lending standards and a slowdown in global growth predicted for next year.