RBA puts spotlight on shadow banking sector risks

The RBA has flagged mortgage default risks are rising as the economy slows down and the labour market weakens amid an ongoing fight against high inflation.

The RBA acting head of domestic markets Carl Schwartz said subprime lending had boomed in recent years while lending from the so-called shadow banking sector had also surged.

The Reserve Bank of Australia has flagged mortgage default risks are rising as the economy slows down and the labour market weakens amid an ongoing fight against high inflation.

The RBA acting head of domestic markets Carl Schwartz said subprime lending had boomed in recent years while lending from the so-called shadow banking sector had also surged.

That lending has been funded in the $165bn securitisation market, where mainly non-bank lenders and subprime lending specialists sell bonds backed by the cash flows from a pool of loans, such as mortgages, SME loans, car loans or credit card debt.

Big banks have shunned the so-called asset-backed bond market in recent years because they have had access to much cheaper funding sources, including near-zero cost term funding from the RBA during the pandemic, cheap deposits and cheaper unsecured bonds.

He said there were now less prime residential mortgage-backed securities and more so-called non-prime bonds, backed by riskier loans to borrowers who don’t meet strict lending standards or to those with poor credit histories.

And with higher interest rates and higher inflation, Mr Schwartz warned this shadow-banking sector was now facing higher risks, as repayments become “an increasing share of household income and unemployment is forecast to rise,” he said.

Speaking at the Securitisation Conference in Sydney, Mr Schwartz said the central bank considered “the outlook for non-banks’ housing loan quality is more challenging than in recent years because some are relaxing lending standards and have found it difficult to retain more creditworthy borrowers.”

Arrears in both prime and non-prime asset-backed bonds have risen in recent months but have remained below pre-pandemic levels, even after 13 interest rate increases by the RBA since May last year.

But inventors at the same conference said they expected bad debt losses to increase moderately in 2024 as interest rates remained higher for longer and unemployment potentially increased.

Mr Schwartz also said that on top of higher potential arrears, securitisation participants also had to consider higher funding costs faced by both bank and non-bank lenders, as well as the impact of competition in the lending markets.

A period of intense competition in the mortgage market – and particularly in prime homes – had priced non-bank lenders out of it, leaving them to lend to small businesses instead.

With the level of competition easing in recent months, Mr Schwartz said it was unclear if they would remain focused on those alternative segments or they would try to move back into mortgages.