The Reserve Bank of Australia (RBA) is considering what it can do to temper soaring house prices, which is triggering mounting household debt and threatening the nation’s financial stability.
Despite previous public statements from Governor Philip Lowe that house prices were not the RBA's responsibility, assistant governor Michele Bullock revealed that it was assessing "tools" that "could be employed in Australia" to manage the risks associated with house prices.
The ever-growing property market, and any potential house price crashes, poses a potential “financial stability risk,” Bullock said.
“The prospect of large declines in property prices presents significant balance sheet risks for households, businesses and lenders,” she said in a speech on Wednesday.
Strategies that were previously adopted during the Global Financial Crisis (GFC) are no longer appropriate because the risks the property sector faces today are different, she said.
“Tools that address serviceability of loans and the amount of credit that can be obtained by individual borrowers are more likely to be relevant,” Bullock said.
“We have seen such tools used in a number of countries in recent times and they could be employed in Australia should the circumstances be judged to warrant it.”
And whilst Bullock said the Aussie property market prices saw a “surprising and dramatic rebound” when the pandemic hit, this has also brought new risks.
“Strongly rising housing markets and housing credit have been a feature of many other countries over the past 18 months as monetary policy has lowered lending rates and governments have provided fiscal support,” Bullock said.
“However, while household debt to income in Australia hasn't increased much over recent years, it is at a high level, both historically and relative to other countries.”
If we continue to see sustained growth in household debt, growing at a faster rate than wages, then Aussie homes and our large financial institutions could be in trouble, Bullock said.
What could happen to households?
The vast majority of debt that Aussie households have is mortgage debt, meaning that a collapse in the property market would leave many unable to pay their loans.
“Households that have borrowed a lot to purchase a home relative to their income could, in the event of a shock to their employment status or income, find they are unable to continue to service their loans,” Bullock said.
Should the housing market crash, Aussies would be left unable to pay their mortgages and saddled with large debts even after selling their home, she added.
This is particularly problematic for young people who are entering the housing market for the first time, Bullock said.
“Rapid price rises can increase the likelihood that some new borrowers will over-stretch their financial capacity in order to obtain a new loan, making them more likely to reduce their consumption in response to a shock to their incomes,” Bullock said.
“Second, if rapid price rises ultimately prove to be unsustainable [it] could lead to sharp declines in price and turnover in the future.”
Experts have signalled they expect rising property prices to continue. But this will put more strain on those who may have purchased a property they can only just afford, according to Bullock.
“When prices are rising very rapidly and there are expectations that this will continue, borrowers are more likely to overstretch their financial capacity in order to purchase property,” she said.
“We are therefore watching developments in housing markets and credit very closely.”
What could happen to the banks?
Australia’s banks are highly exposed to the Aussie housing market with around 60 per cent of their lending going towards housing.
But the banks will be left severely out of pocket in the event of an economic shock that would see Aussies unable to make their repayments, triggering a housing market decline, Bullock warned.
However, she conceded this was somewhat unlikely, as the events of the past year have shown the banking sector’s resilience.
“The more well capitalised the banking system, the more ability it has to absorb losses. The GFC, which originated in a boom and bust in the housing market in the United States, demonstrated what can happen if banks are not well capitalised,” Bullock said.
Banks around the world that copped substantial losses during the GFC ultimately exacerbated the economic downturn due to their severely depleted financial positions, she added.
But Australia was able to avoid the otherwise global crisis thanks to Aussie banks which were "well capitalised" at the time, she said.
“While the Australian banks did not have the undercapitalisation problems of some overseas banks, they now have even stronger capital positions than they did at the time of the GFC.”
Bullock said the RBA conducted a stress test in October last year, finding that even a severe recessional and substantial fall in property prices would still leave our banks with enough capital to stay afloat.
“The strength of the banks allowed the banks to respond positively to the pandemic shock, supporting the economy through lending and loan repayment deferrals rather than amplifying the shock,” she said.
What can we do to mitigate the risk?
Bullock said the risks are building, and the RBA is focussed on what can be done to help fix the problem before it starts.
The stability of Australia's financial system is under threat amid rising house prices coupled with escalating household debt, she said.
“Even though the banks have strong balance sheets and lending standards are being maintained, there is a risk that in this environment, households will become increasingly indebted,” she said.
“A high level of debt could pose risks to the economy in the event of a shock to household incomes or a sharp decline in housing prices. It is these macro-financial risks that warrant close watching.”
In effect, the RBA is considering using the tools at its disposal to address rising house prices, despite previous statements that it would not be getting involved.