Credit squeeze risk heightened by unco-ordinated regulators

Ignorant of history, our regulators are blind to the way their combined actions risk hollowing out the economy.

Left to right, RBA governor Philip Lowe, ASIC chair Greg Medcraft and APRA chairman Wayne Byres on a panel. Picture: Adam Yip.

Few if any of Australia’s banking and finance regulators have had personal experience with the way a credit squeeze affects the economy, because the last credit-driven downturn was in the mid 1970s.

That inexperience presents one of the greatest risks the nation faces because credit squeezes impact economies in a very different way to downturns created by higher interest rates, such as the one that occurred in the late 1980s.

Higher interest rates are like an open book: you can see what is happening. Credit squeezes, on the other hand, are like termites. On the outside, the economic structure looks good. But then suddenly the house falls down. This risk was made very clear to me when I attended this week’s FINSIA Regulators luncheon, which was addressed by senior officials from the Reserve Bank, APRA and ASIC.

For me the danger of that regulatory inexperience was underlined by two side events. First, while it was probably a coincidence, as the regulators were speaking the sharemarket began falling. Granted it later recovered. It’s the sharemarket that is warning of the dangerous steps the regulators are taking.

The second event is a bizarre but true story I uncovered. An elderly lady was recently widowed and between her and her late husband they had wealth of between $50 million and $100 million. But that wealth was tied up and the main access points were in joint names.

She tried to get a credit card from her big four bank and was told in no uncertain terms she could not get one because she had insufficient income and the form she filled in did not meet the requirements. This true story illustrates a situation created by bankers’ fear of regulators and is not isolated. Indeed I know of another millionaire, with no debt, who has been told they could not have credit cards by the same bank. I am sure that big four bank is not unique.

It underlines how frightened bankers have become of the regulators. In the case of the widow I believe someone alerted a senior executive of the bank and common sense prevailed. But I tell the story to illustrate what taking place all over the land: that’s how credit squeezes eat into the fabric of a nation without appearing in the official data.

At the FINSIA function it became clear to me that each of the regulators had set themselves an agenda. Each agenda, on its own, was perfectly reasonable. The Reserve Bank wants to improve the lending quality of Australian banks and had isolated investor lending as the most dangerous area. For two years it has been working to improve that sector by restricting the amount of loans banks can make to investors, particularly interest only loans, and there have also been interest rate rises for investors.

The Reserve Bank is very happy because it believes that bank balance sheets are now in better shape and will be even better in two years. And on its own, that is probably a very good strategy for the nation and the banking system. But APRA and ASIC are now more vigorously entering the game with the objective of making banks look after customers better and improve their governance. Again, in isolation, these are worthwhile objectives.

APRA and ASIC are also going to examine what banks do in great detail, including going into individual banks and examining transactions looking to make sure that the consumer has been looked after and all the governance rules have been obeyed. They will be looking at board policies and how they are implemented. Banks who do not “look after customers” will find they must take the losses — not the customer — which creates fear among bankers at all levels and restricts lending.

It is as though banks are totally out of control and need public servant regulators —-usually with a treasury backgrounds — to show them how to do their business. And all this is being driven by the outcomes of the royal commission, which will next year set out how to remedy the series of incidents of bad bank behaviour that it has uncovered. The regulators are primed and ready to implement every royal commission word while APRA, as well as implementing its own banking restrictions, will also make sure that ASIC and any other regulators do their job.

The underlying aim is to make sure the Australian banking system can handle a serious downturn. But all this is happening after a boom during which there was virtually unlimited credit. The bottom line is that we are decreasing the amount of bank lending in areas of housing by about 20 to 30 per cent and this is going to translate into house price falls of between 10 and perhaps 30 per cent.

In some areas like inner city apartments, prices have already dropped 20 per cent and are still falling. And with every fall in dwelling prices, the amount of lending is further decreased, creating a vicious downward spiral.

It was apparent from the speeches at the FINSIA lunch that there is no clear understanding of what is ahead. Currently there is a well overdue correction in dwelling prices taking place and if that is as far as it goes the economy will take it in its stride. That’s why the current economic figures are so strong.

But the message from the regulators is that the regulation-driven credit squeeze is going to get much more severe. After all, the banks need greater regulation and punishment. That means that almost inevitably, the rate at which housing prices fall will accelerate in 2019 and with that will come a substantial fall in economic activity, consumer spending, building and corporate profits. That is what the sharemarket is now coming to grips with. The only cushions will come from the heavy borrowing being undertaken by governments to fund infrastructure, plus increased activity in mining and tourism.

In seeking to protect the banking system from a downturn, the regulators are in grave danger of creating the very thing they are trying to protect the community from. Paradoxically, one of the areas that will be hit hard is residential property developers, who are being starved of cash. In due course, that will lower the levels of dwelling creation, particularly in apartments. In time that contraction of dwelling supply will push up rents and stabilise the dwelling market but there will be a lot of pain on the way. All we can hope is that as 2019 progresses the regulators will wake up that trying to do all these things at once after a boom is extremely dangerous and they will ease off. But at the financier luncheon there was no sign that they had any idea of the dangers the nation is facing as a result of their combined actions.

Footnote: The Liberal National government today announced it is providing an additional $51.5 million to the Commonwealth Director of Prosecutions and to the federal court to enable further prosecutions of criminal misconduct by banks and other financial intuitions and to ensure civil claims are dealt with effectively. The government will be cheered but the risk to the financial system outlined above its multiplied as bankers fear for their personal liberty as well as their jobs.