RBA to stress-test banks amid mortgage fears
The Reserve Bank has revealed deep concerns about the property market, warning that interestonly borrowers are vulnerable to “payment shock” and that many households could be forced to dump their homes on the market.
In a stark admission of the heightened threat to financial stability amid ever rising household debt and high property prices, the RBA will launch “top-down stress tests” of the banking system, which will be carried out on top of the supervision from the Australian Prudential Regulation Authority, raising the prospect that further regulatory action will be taken against still rampant lending from the banking sector.
The warning came as Citi analyst Craig Williams suggested interest-only mortgages could be the country’s Achilles heel. The Citi report warns of the risk presented by Australia’s reliance on interest- only loans, which account for more than a third of all mortgages.
The stress tests add another layer of scrutiny on the banking system, as concerns rise about the resilience of borrowers to higher interest rates and jumps in unemployment.
Banks are being investigated by the corporate watchdog for possible breaches of responsible lending laws when interest-only loans
are sold to customers. Investment bank UBS has found that onethird of interest-only borrowers are unaware they are not paying off their mortgage.
Yesterday’s release of the RBA’s Financial Stability Review is the first since APRA’s announcement in March requiring banks to limit the sale of interestonly loans, which don’t require any payment on principal for a period of about five years.
The RBA said that, since limiting interest-only loans to 30 per cent of lending, housing markets in some areas — such as Brisbane, Sydney and Melbourne — had cooled. The central bank said tighter rules and higher interest rates for interest-only loans were constraining households and developers, although there were few issues with settlements so far.
The RBA outlined several concerns with the high rate of interestonly borrowers in the market. It said these households remained more indebted throughout the life of the loan than other borrowers, making them “more vulnerable to higher interest rates, reduced income, or lowering house prices”.
“Such households are also more vulnerable to ‘payment shock’ due to the increase in repayments following the end of the interest-only period of the loan,” the central bank said.
Recent regulatory overhauls to shore up responsible lending laws mean investors must now have a clear debt repayment plan when applying for a loan.
“For many prevailing interestonly borrowers this does not exist,” Mr Williams said. “The large levels of debt outstanding by borrowers aged in their 50s and 60s means many investors will need to sell property to discharge their debts.”
The RBA said the “key risks” in the local financial system stemmed from household borrowing. Household debt has contin- ued to climb amid record-low interest rates, recently touching a debt-to-income ratio of 194 per cent — one of the highest in the world. “Higher interest rates, or falls in income, could see some highly indebted households struggle to service their debt and so curtail their spending,” the RBA said.
Mortgage buffers where households were well ahead of their repayments “mask substantial variation” in the market, with onethird of all borrowers less than one month ahead on their loan.
The number of investors who own multiple properties has also been exploding, with the number of investors owning five properties growing by 7.5 per cent in a single year. Ten per cent of investors own more than two properties.
“The strong growth of investor borrowing for property in recent years has potential implications for financial and macroeconomic stability,” the RBA said. “Many investors are lower-to-middleincome earners with a substantial share of households in lowerincome occupations experiencing losses on their rental properties.”
Mr Williams said another threat of interest-only lending was that it was skewed towards older cohorts of borrowers who were taking advantage of tax breaks such as negative gearing and capital gains discounts. Many owneroccupiers had relied on interest- only loans to access the market amid surging house prices. The loan type allows a borrower to access larger loans.
Citing research from Digital Finance Analytics principle Martin North, Mr Williams said one-third of senior property investors did not have a loan repayment plan, while another third were never asked about plans to repay their loan on their mortgage application. “As these cohorts begin to hit retirement age, their investment properties will need to be sold to repay the debt,” Mr Williams said. A recent UBS report found one-third of all borrowers had given false information to a bank or broker to obtain a loan.
Brian Harzter, chief executive of Westpac — the nation’s largest lender to investors with more than $200 billion worth of interest-only loans on its books — this week told parliament that interest-only loans were “not a giant credit issue” and that the RBA was more concerned with a squeeze on incomes in the event of higher rates.
“I have personally spoken to the governor of the Reserve Bank, who has confirmed to me that the Reserve Bank’s concern is not about the credit quality of the Australian banks; it’s a concern about the economic resilience of the nation in the event that interest rates rise,” Mr Harzter said.
Mr North believes there are almost 2 million investment properties across Australia that will come under “selling pressure” in coming years, which could be exacerbated if house prices fall and encourage investors to sell out of the houses.
The RBA said “substantial additions” to the number of apartments in places such as Brisbane and Melbourne had already caused prices to fall.
The central bank’s new stress test will investigate what happens to banks amid a system-wide economic shock. It will fill the gaps in APRA’s current stress tests by finding out how shocks “propagate” through a bank’s balance sheet, and the results will be featured in future RBA publications.
JPMorgan analyst Ben Jarman said the RBA’s comments on investor lending conveyed “a sense of dissatisfaction that not enough has yet been done to rein in activity”. On Thursday, official figures show investor lending hit its highest rate in two years.
“The introduction of this topdown test is a somewhat unusual development, given the separation of powers between the RBA and APRA,” Mr Jarman said.
“It is not hard to imagine such simulations being used to support the argument that macroprudential policy can be tightened further.”
Westpac CEO Brian Hartzer says interest-only loans are not ‘a giant credit issue’