The Financial Services Royal Commission has exposed some irresponsible lending by Australia’s biggest banks.
Some of the revelations from the commission have affected certain banks’ share prices but not their profits.
The question is whether the information brought to light by the commission will further push down property prices?
Here are their detailed responses:
Harry Schedule, professor of finance – YES
The shortfall of wages to pay for housing costs has made Australia’s household debt to GDP ratio one of the highest in the world (approximately 100%).
Another worry of this debt explosion is that mortgages account for over 60% of Australian bank assets and the banking is dominated by few large banks. Their failure has the potential to disrupt the economy. The Australian Prudential Regulation Authority (APRA) has responded by tightening lending standards.
The royal commission will lead to a greater risk awareness in the banks and as a result a re-balancing of the amount of loans banks make compared to consumers’ potential earning and debt repayment. APRA has made it clear in its submission to the commission that it expects banks to better reflect household living expenses and mortgage interest payments, in their calculations on how much they lend.
The effect of these changes will be that banks reject more consumers who apply for loans and offer less of them going forward. Home buyers will then have less ammunition available in bidding for real estate which will eventually dampen house prices. It will be interesting to see whether these changes will make houses more affordable. But much will depend on whether or not people get a wage rise.
Rachel Ong, professor of economics – NO
One of the key outcomes from the Financial Services Royal Commission is the tightening of banks’ lending standards and stricter credit controls. As a result, households may find it more difficult to get home loans and borrowing costs may rise.
Theoretically speaking, this should lead to a reduction in demand for properties. However, this prospect is unlikely to translate into any meaningful reductions in property prices. Property prices in Australia have remained persistently high since the early 2000s.
This reflects policy settings that have systematically encouraged over-investment in property, over time. These policy settings include negative gearing and capital gains tax discounts, the First Home Owners Grant, as well as decades of financial deregulation and historically low interest rates.
It’s unlikely that the financial services royal commission will lead to any sudden hikes in interest rates or meaningful changes in policy settings, that have fuelled competition for property in the markets thus far. Property prices in Australia will continue to remain stubbornly high, reflecting a long-term structural problem that has been neglected by policymakers for decades.
Brendan Coates, fellow – YES
Tighter lending standards to reduce the amount of money prospective homebuyers could borrow would push down property prices, at least in the short-term. But the effect is likely to be modest, because banks have already tightened lending criteria in recent years.
The royal commission has focused on banks’ compliance with responsible lending laws, which require lenders to make “reasonable inquiries” about an applicant’s financial situation before lending money, and the use of the Household Expenditure Measure to assess living expenses. Given the controversies the commission has exposed, tighter rules are likely.
But the banking regulator, the Australian Prudential and Regulatory Authority (APRA), has already tightened lending standards. Since 2014 it has required banks to assess borrowers’ ability to repay the loan at an interest rate of at least 7% – more than three percentage points above current discounted mortgage rates. These changes have had a material impact: the share of new loans, where the loan exceeds 80% of the purchase price, have declined sharply since 2014 and overall credit growth has slowed.
APRA also recently removed the 10% cap on growth in investor lending, which could offset the impact of any tighter lending rules arising from the royal commission.
Cameron Murray, lecturer in economics – YES
One of the main factors enabling the enormous house price increases over the past six years has been easy access to mortgage finance. We can already see reports of more conservative lending happening this year, and further tightening of lending standards due to the Financial Services Royal Commission will reduce the ability of potential housing buyers to bid up prices.
It’s essential to keep in mind the buyers who set prices in the housing market are usually investors. So what matters is how lending constraints and recent price trends affect investor demand. Investors have been rather quiet on the markets lately, with first home buyers making up a recent high of 18% of new mortgages.
The downturn in prices in the housing market that we are now seeing could be short-lived. Outside of Sydney (and Melbourne to a lesser extent) returns might seem relatively attractive for investors. Another price boom could begin next year as lenders find that the only buyers that fit their new tight qualifications are outside of areas with already inflated housing prices.
Remember, housing markets are ruled by feedbacks — price rises attract more buyers, further increasing prices. The reverse also holds. So the net effect of tighter lending controls due to regulatory changes that come out of the commission depends on whether the shock is big enough to send the market into a downward spiral, or only temporarily halt the current upswing.
Maria Yanotti, lecturer in economics – NO
The royal commission is more likely to affect the supply of financial services, than demand for loans. As a consequence of the commission’s findings we would like to think that financial institutions will have to put in place better compliance processes and stop cost-saving or income-generating practices that disadvantage or put consumers at risk.
These new processes and practices will translate into higher costs for the financial institutions, which will be passed on to consumers via higher interest rates and/or lower access to finance. Banks already need to collect more data on their consumers to accurately assess their risk in taking certain products, particularly home loans.
This situation will result in lower demand from those looking to own a home, in favour of higher demand for rental housing. But the effect of higher interest rates may not be strong enough to decrease demand for property by real estate investors and businesses.
We have to keep in mind that the financial services industry is also facing major technological changes, which will potentially lower the cost of providing financial services to consumers.
And even though the reputation of many of our financial institutions will be tarnished by the commission, the industry is still an oligopoly and consumers don’t have many alternative choices for real estate finance.
Real drivers of property prices are land availability, construction costs, population growth, and to a lesser extent finance access and cost.
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Cameron Murray is a senior economist at The Australia Institute and member of the Sustainable Australia political party.