Reserve Bank warns 40 per cent of households have less than three month mortgage buffer

The Reserve Bank has warned 40 per cent of all households have a less than a three-month buffer in mortgage repayments.

The Reserve Bank has warned four in ten households have less than a three-month buffer in mortgage repayments, and a small group of borrowers with low savings and a high level of debt could fail to meet their repayments.

In its latest Financial Stability Review, published on Thursday, the central bank said despite a strong labour market, income growth had not kept up with inflation and that left more households with less capacity to service their debts.

The review came as the RBA left rates on hold at 3.6 per cent on Tuesday, after it lifted the cash rate by 3500 per cent across 10 consecutive interest rate hikes in the past year.

“While many borrowers have significant buffers, around 40 per cent of loans have less than three months of prepayment buffer,” the report said.

“Borrowers with these loans are potentially more at risk of struggling to service their debts, particularly if they experience shocks to their income or expenses,” the report said.

The RBA expected that many households would to manage to repay their debt by reducing their spending and/or their rate of saving.

“As a result, housing loan arrears rates are likely to increase in the period ahead from currently very low levels. Debt-servicing challenges will become more widespread if economic conditions, particularly the level of unemployment, turn out to be worse than expected and housing prices fall sharply,” the RBA said.

The warning comes as nearly 900,000 households who fixed their rates during the pandemic will transition to variable rates followed by 450,000 in 2024.

Betashares chief economist David Bassanese said the fixed-rate mortgage cliff would be the equivalent five 25 bps interest rate hikes.

“Given this lagged policy impact, it’s little wonder the RBA this week announced a pause in hiking rates,” he said.

“In reality, the higher than usual expiry of fixed-rate mortgages over the coming two years will result in de facto policy tightening (at least on the mortgage sector) equivalent to around one third of the policy tightening already seen over the past year.”

The RBA’s review also noted that global financial conditions had tightened this year as persistently high inflation prompted central banks in advanced economies to rapidly raise interest rates.

The RBA, led by governor Philip Lowe, kept the cash rate on hold at 3.6 per cent on Tuesday. Picture: Gary Ramage/NCA NewsWire

“Financial asset prices have declined and volatility has increased. Housing price growth has slowed or reversed in many economies in response to higher interest rates. Severe disruptions in energy markets have led to stress in some parts of the global financial system,” the report said.

Growing headwinds in recent months have seen the world’s banking system come into question with the collapse of three regional banks in the US and the forced sale of Credit Suisse to UBS.

The RBA said that Australia had a resilient, well-capitalised and profitable banking system that strong liquidity, leaving it well placed to whether the challenging financial environment.

Stress-testing simulations conducted by the RBA suggested that banks would be able to continue extending credit to households and businesses even if economic conditions were to be materially worse than expected.

“Banks’ current profitability and high initial capital levels would support capital ratios in an economic downturn. While exercises of this type contain considerable uncertainty, they give an indication of the impact on banks of a severe economic downturn,” the review said.

In a scenario where the level of GDP falls by around 5 per cent, the unemployment rate rises to 5.5 per cent and property prices fall by around another 10 per cent by December 2023, the RBA said large and mid-sized banks’ CET1 ratios would fall by around 160 basis points but would still be above minimum capital requirements.

“While smaller banks’ exposures are typically more concentrated in mortgages, high initial capital levels indicate that smaller banks in general could absorb losses associated with weaker macroeconomic conditions for a time while maintaining CET1 ratios above minimum requirements.”

The Financial Stability Review, which is published in April and October each year, also reported that any “significant cyber event” could undermine confidence in the financial system and have systemic implications.

The fear has seen APRA instruct banks to tighten their controls further where possible to limit the risk of fraud.

“A cyber-attack of this size has potential systemic implications, as an increase in fraudulent activity associated with the leaked information could undermine confidence in banks,” the RBA said.

“APRA is also undertaking consultations on strengthening operational risk standards for banks, insurers and superannuation funds, which could include new requirements on operational risk and updated requirements on business continuity and managing third-party service providers.”

The RBA added that climate change presented a challenge to the financial system with institutions vulnerable to direct losses on assets from climate events and the transition to a lower emissions economy.

This has seen regulators focus on improving the ability of businesses and institutions to disclose and manage financial risks associated with climate change.