RBA's Lowe takes aim at desperado borrowers

Australian Financial Review Apr 4 2017 8:49 PM

Jacob Greber

Reserve Bank of Australia governor Philip Lowe has warned too many banks are giving loans to badly stretched borrowers, increasing the risk of a wave of defaults if even small shocks hit the economy.

In a clear shot at both state and federal governments, Dr Lowe also insisted that boosting supply is the only real way to break the trend of house prices outpacing incomes and that the latest regulatory crackdown on lending is only a stop-gap measure.

"Too many loans are still made where the borrower has the skinniest of income buffers after interest payments," Dr Lowe said late on Tuesday.

The remarks came after the Reserve Bank left the cash rate steady at 1.5 per cent for a seventh-straight meeting – effectively trapped by the need to avoid adding more fuel to the property market with another rate cut while being unable to hike because unemployment has worsened and inflation remains too weak.

Markets took the decision as a sign of fresh dovishness within the bank on the state of the labour market and inflation, pushing the Australian dollar as low as US75.57¢ from as much as US76.15¢ before the announcement.

Banks have been told by the Australian Prudential Regulation Authority that they need to cut the proportion of interest-only loans they issue to 30 per cent from 40 per cent, and warned that regulators are targeting banks issuing loans to borrowers with less than $200 a month left over after expenses and mortgage repayments.

Amid concerns such loans are akin to the disastrous "subprime" mortgages that plunged the US and global economies into crisis in 2008, Dr Lowe warned Australian banks they needed to maintain a "very strong focus on serviceability assessments".

"In some cases, lenders are assuming people can live more frugally than in practice they can, leaving little buffer if things go wrong".

The governor backed APRA's move to restrict the number of loans that don't expect repayment of the principal for the first five years – also known as interest-only mortgages – but acknowledged that Australia's financial system is different to other countries with similar issues because households can make extra payments into offset accounts.

"This flexibility, which is of value to many people, isn't available in most countries," he said, noting that another driver of the popularity of interest-only loans was negative gearing and capital gains tax discounts on residential investment, a politically sensitive point.

"A reduced reliance on interest-only loans in Australia would be a positive development and would help improve our resilience," he said. "With interest rates so low, now is a good time for us to move in this direction."

He urged more borrowers to consider "the merit" of taking out very large interest-only loans when borrowing costs are near record lows.

In a thinly-veiled retort against critics of the Reserve Bank's two 2016 official interest-rate cuts, which some believe are the primary reason for rampant house-price growth in Sydney and Melbourne, Dr Lowe insisted the cost of money was less of a driver of double-digit house price growth than a lack of supply of homes and good infrastructure.

"The availability of credit is undoubtedly a factor that can amplify demand, but it is not the root cause," he said, pointing out that property markets currently vary widely across the country despite there being only one official interest rate.

"It is hard to escape the conclusion that we need to address the supply side if we are to avoid ever-rising housing costs relative to our incomes and to avoid the attendant incentive to borrow that is created by rising housing prices."

The governor warned that prudential restraints won't address that underlying supply-demand mismatch, which has intensified since the turn of the century because of an unexpected acceleration in population growth and a lack of investment in transport links to unlock fresh housing.

Macroprudential action can lessen financial risks from the housing market and lessen its impact on the broader economy, ideally if banks start "acting themselves, without the need for prudential guidance".

He warned that regulatory intervention on banks was neither "precise or straightforward".

"We need to keep matters under review," he warned.

"In the end addressing the supply side of the housing market is likely to prove a more durable way of dealing with the concerns that people have about debt and housing prices than detailed supervisory guidance."

Key regulators, which include the Reserve Bank, have in recent days announced a raft of curbs on bank lending to investors and riskier categories of borrowers.

The governor's speech supports speculation that monetary policy has been effectively sidelined for now, with the central bank caught between avoiding a property bubble and crunching a household sector reeling under record debt and record-low wages growth.

"Household debt in Australia is high and it is rising," he said, with the value of housing-related debt outstanding increased by 6½ per cent compared with 3 per cent household income growth.

"At the same time ... slow growth in wages is making it harder for some households to pay down their debt," he said.

Dr Lowe reiterated his view that the global economic outlook has brightened considerably this year, while acknowledging that the labour market is still "pretty soft".

"Growth in employment is slow and wage growth is the lowest in some decades," he said.

"We will want to see an improvement here before we can be confident that growth in the overall economy is strengthening."

The impact of cyclone Debbie in Queensland and floods in northern New South Wales are also still to be determined.