Reserve Bank says house price growth being ‘watched closely’

The RBA has zeroed in on risks from the home price boom in its latest stability review, but says banks could cope with any shock.

The RBA has highlighted risks in the property market but is confident banks can cope with any significant deterioration. Picture: Joel Carrett

Australia’s housing market is being “closely watched” by regulators as cyclically low interest rates and rising house prices “create a risk of excessive borrowing”, according to the Reserve Bank.

While strong growth in Australian house prices in recent months hasn’t been accompanied by a significant build-up in debt, “globally risks associated with asset prices and debt could build”.

In the bank’s semi-annual Financial Stability Review, it cautioned that “a sustained period of rising asset prices may lead to overexuberance and extrapolative expectations, with increased risk-taking and leverage in an environment of accommodative financial conditions.”

“In this situation lending standards could weaken, with asset prices being pushed above their fundamental values,” the RBA said.

“A correction in asset prices, if borrowers’ income were to fall and so they defaulted on debt repayments, would expose lenders to large losses on the increased debt, particularly if the quality of that debt had been eroded.”

The explicit warning of the consequences of excessive risk taking by the nation’s central bank came after CoreLogic’s national house price index rose 2.8 per cent in March, the fastest pace since 1988.

CoreLogic’s Home Property Value Index rose 5.4 per cent in the first three months of the year.

House prices in Sydney rose 3.7 per cent in March and 6.7 per cent over the first quarter.

The RBA noted that in Sydney and Melbourne house prices are now “a little above the historical peaks they reached in 2017-2018”, albeit house prices in regional areas rose by 11 per cent over the past year compared with 5 per cent in capital cities.

RBA Governor Lowe said on Tuesday that the RBA is “monitoring trends in housing borrowing carefully and it is important that lending standards are maintained.”

In its latest financial system health check on Friday, the central bank warned that “in an environment of accommodative financial conditions with rising asset prices it is particularly important that there is not excessive risk-taking by the financial sector.”

The RBA noted that increased risk taking by lenders could take the form of looser lending standards for individual loan assessments, or a relaxation of internal limits on the share of riskier loans they make. But even if lenders don’t weaken their own settings, “increased risk-taking by optimistic borrowers could see a deterioration in the average quality of new lending.”

“This would weaken the resilience of businesses and households, and so the financial system, to future shocks,” the RBA said. “Increased risk-taking would fuel rising debt, from already high levels, increasing the debt-related risks to the economy and financial system from a fall in asset prices and borrowers’ income.”

In a veiled warning of “macroprudential tools” — such as formal limits for debt-to-income and loan-to-income — to cool the property market, it noted an improvement in lending standards from the mid-2010s “helped to ensure borrowers were well placed to weather the economic shock over the past year, demonstrating the benefits to the financial system and the economy of appropriately controlling risks.”

In March 2017, APRA tightened macroprudential policies due to “an environment of heightened risks” and APRA chair Wayne Byres said the regulator “views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile” in the housing market.

Macroprudential tools deployed at the time included limiting new interest-only lending to 30 per cent of total new residential mortgage lending – with strict internal limits on the volume of interest-only lending at loan-to-value ratios above 80 per cent – and APRA’s insistence on “strong scrutiny and justification of any instances” of interest-only lending at an LVR above 90 per cent.

RBA Governor Lowe chairs the Council of Financial Regulators, which includes the RBA, APRA, the Treasury and the Australian Securities and Investments Commission, with a mandate to contribute to the efficiency and effectiveness of regulation and the stability of the financial system.

The RBA has repeatedly said it won’t use monetary policy to try to contain the housing market, but that it has other tools available to excessive risk taking in the property market.

Still, the Financial Stability Review said that “the share of high LVR lending increased over the second half of 2020 but remains low by historical standards” and the share of interest-only lending has been “little changed at low levels”, while the share of lending at high debt-to-income ratios increased over the second half of 2020 after earlier declines.

“Credit growth has increased but remains modest and has mostly been driven by lending to owner occupiers” although “investor loan commitments have started to rise”, the RBA said.

Westpac chief economist Bill Evans said loan approvals points to investor commitments rising 31 per cent in the last six months compared 24 per cent for ‘upgraders’ and 30 per cent for first home buyers. But importantly, loan approvals to investors account for around 32 per cent of the total housing loans (including all owner occupiers) compared to 65 per cent in 2017 when APRA introduced a range of controls aimed at curtailing investor activity.

Demand for inner-city apartments is likely to remain constrained in the near-term given changes in housing preferences and a sharp fall in immigration, but the short-term risk of oversupply is limited by the relatively low volume of expected apartment completions in 2021, the RBA said.

For commercial property, the risks are greatest for retail and also offices, with office vacancy rates in the Sydney and Melbourne CBDs are currently around their highest in 20 years.

While banks do face some challenges in rising non-performing loans as a result of the economic downturn and refinancing their funding from the term funding facility in three years’ time, both of these “seem very manageable” and risks in other financial institutions “appear contained”.

“Banks’ non-performing loans have increased, but by less than expected, and their current provision balances are expected to be sufficient to absorb the impact of future defaults.”

While the vast majority of households and businesses who had deferred loan repayments have now resumed full repayments, some increase in household and business financial stress is likely as temporary support measures end and borrowers deplete their financial buffers.

The JobKeeper wages subsidy and JobSeeker supplementary dole payment expired last month.

The RBA’s reverse stress testing model implies that it would take a recession comparable to the Great Depression for banks’ regulatory capital ratios to fall below 6 per cent.

But APRA’s and RBA’s results are “subject to considerable uncertainty” and “it is possible that greater stress could arise from factors that are not well captured by the modelling.”

The central bank noted that financial systems globally have been “resilient to the enormous COVID-19 health and economic shock” due to “substantial policy support from governments, central banks and other regulators”, central banks have committed to keep policy interest rates very low for several years, and expectations of a sustained recovery in activity in most economies, have contributed to rising asset prices, and indebtedness in some sectors.

But “if risk premiums were to rise from low levels, then long-term bond yields could jump higher, leading to falls in a broad range of asset prices that are underpinned by the low level of risk-free interest rates,” the RBA warned.