The nation’s largest mortgage lender, the Commonwealth Bank of Australia (CBA), has announced that it is tightening its criteria for home loans for foreigners.
The CBA will no longer approve applications for home loans that cite self-employed foreign income, according to a note sent to mortgage brokers this week.
The bank also says it will no longer accept the foreign-currency income of temporary Australian residents. These individuals can also only borrow up to 70% of a property’s value, compared with the previous rate of 80%.
Home loan applications from foreigners make up a “significantly low proportion of our total home loan applications” according to a CBA statement, adding, “We constantly review and monitor our home loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs.”
The fact that home loans for foreigners make up a relatively small segment of the market means CBA’s new policy should not have major consequences for mortgage brokers, according to principal at Ocean Home Loans, Brad Kirwan.
“This is a very small part of the overall market,” he told Australian Broker. “Self-employed foreign investors are an even smaller part of that market. Most lenders won’t accept foreign self-employed income anyway – I’d suggest that CBA are aligning their policy with the other major banks so as not to be over-exposed to one particular type of applicant.”
When asked what steps brokers might take in response to CBA’s changes, Kirwan added, “There are several large brokerages that focus entirely on the Chinese market and have done very well over the past few years, they will obviously have to reassess how they do business in the future, for the majority of mortgage brokers it will be business as usual.”
Category: Economics and Banking
Basel Committee’s Attempt to Classify Problem Bank Assets Would Aid Bank Analysis
Last Thursday, the Basel Committee on Banking Supervision (BCBS) published a consultative document on the classification of problem assets, including definitions of nonperforming exposures (NPEs) and forbearance. The lack of a consistent definition of these terms among countries and banks makes bank analysis complex and fuels scepticism of banks’ disclosures. Consistent definitions would aid investors and risk managers in their analysis of banks’ soundness.
The BCBS’ proposed definition of NPE incorporates the following characteristics:
- NPE status applies to all credit exposures, including debt securities
- All exposures to a given counterparty, including uncancellable off-balance-sheet exposures, are classified as an NPE if one transaction is classified as an NPE
- Complementing 90-day past-due criteria with a qualitative assessment of debtors
- Not considering the value of collateral when identifying an NPE
- The ability to upgrade an exposure to performing, contingent on objective criteria
For forbearance, which has no formal international definition, the BCBS recommended a scope identical to the one used with NPEs, with clear identification of forbearance exposures concessionally granted to counterparties facing financial difficulties. The proposal also states that forborne exposures can be either performing or nonperforming, depending on the exposure’s status when the forbearance is extended. Exit from the forborne category would be based on objective criteria, and forbearance status should not result in a reduction in provision requirements.
The need for a single set of guidelines is the result of the BCBS’ assessment of the regulatory frameworks and supervisory practices of 28 jurisdictions. The analysis identified numerous variations, including loan categories based on an accounting layer in eight jurisdictions, on a regulatory layer in 10 countries, and on an ad hoc basis in the remainder. Meanwhile, banks in Asia and the Americas require that exposures classified as nonperforming have six to 12 months of performance before their classification is restored to performing, while in Europe banks are bound by a 12-month time frame. There are also differences in the treatment of collateral and the criteria for income recognition.
An internationally accepted definition of NPE would help improve the identification of such exposures and forbearance and result in more harmonization of banks’ supervisory reporting and public disclosures. A more precise identification of problem loans should force banks to shore up their capital base and reserves. We also expect that specific disclosure requirements in Pillar 3 reports that the BCBS intends to develop will strengthen market discipline. We note that the European Banking Authority’s definition of NPEs and forbearance, published in 2014 before the European Central Bank’s asset quality reviews, prompted some banks in the European Union to significantly increase their provision levels.
The global financial crisis provided evidence that proper categorisation of loans, or lack thereof, has material implications on banks’ provisioning and thus their capital. But for this guidance to be effective, BCBS members would need to fully embrace what would be a voluntary framework. It also remains to be seen whether the BCBS will set a timetable for its implementation and whether the Financial Stability Board would press G-20 members to adopt the framework. Absent these conditions being met, the likelihood of achieving material progress in this area would be slim.
House Prices On The Slide
According to the Domain House Price Report for the March Quarter, Melbourne and Hobart are the only capital cities where house prices are still rising. Sydney’s house prices fell, recording a quarter-on-quarter drop of 1.5 per cent, bringing the median down under the $1 million mark to $995,804. This 1.5 per cent drop when coupled with the 3.2 per cent fall in the December quarter, means prices have now dropped 4.7 per cent over six months. It’s an even bigger drop than Sydney experienced over 2008 during the global financial crisis, when the median dropped 4.6 per cent over the full year.
Canberra house prices fell by 1.4 per cent after five consecutive quarters of growth.
In Perth, house prices dropped by 1.3 per cent to $579,914 over the quarter, while Adelaide recorded a 0.5 per cent drop to $491,422, and prices in Brisbane fell by 0.05 per cent to $512,809.
The report showed that house prices in Hobart surged during the March quarter, rising by 4.3 per cent to $360,212, while Melbourne house prices rose by 1.2 per cent to $726,962.
Darwin house prices dropped sharply by 4.9 per cent to $610,305.
“Weakening economic activity and growing uncertainty is impacting fragile consumer and investment sentiment, leading to falling house and unit prices in most capital cities,” Domain chief economist Andrew Wilson said.
“The outlook for house prices remains subdued, with capital city growth likely to continue to track at best just above the inflation rate for the remainder of 2016.
“The prospect of weaker house price growth, however, will be welcomed by prospective first home buyers still struggling to get into the market.”
The boom’s over, but no crash is imminent. As Dr Wilson points out, the most recent drop in Sydney is less than the one in December. So there could be an even smaller fall in June. It’s not as if there’s been any major trigger to substantiate a more significant correction, like a large rise in interest rates or a jump in unemployment.
UK bank commission head asks central bank to think again on capital
According to Reuters, the Bank of England is too optimistic about being able to close big banks smoothly if they run into trouble and lenders should hold far more capital to keep the financial system safe, the architect of a major banking reform said on Tuesday.
The Independent Commission on Banking (ICB) chaired by John Vickers recommended after the financial crisis that banks ring-fence capital equivalent to 3 percent of risk-weighted assets, while the Bank of England says the level should be 1.3 percent.
In response to previous criticisms from Vickers, BoE Governor Mark Carney published a 13-page letter to parliament on Friday, setting out how why banks in Britain generally hold enough capital to act as a buffer against systemic risk.
But Vickers told an audience including former regulators, central bank officials and Clara Furse from the BoE’s Financial Policy Committee that the assumptions underpinning the bank’s arguments were not realistic.
“The BoE should think again,” Vickers said in his speech at the London School of Economics on Tuesday.
“The Financial Policy Committee should use to the full the opportunity it now has to make UK retail banking safer, and introduce a 3 percent systemic risk buffer for all major ring-fenced banks,” Vickers, a former BoE chief economist, said.
“With more prudent and realistic assumptions, the BoE’s own analysis indicates the need for that. The BoE’s current proposal falls short,” he said.
The spat between Vickers and the BoE over capital levels has irked the central bank and prompted parliament’s Treasury Select Committee to review bank capital requirements.
Carney has said no significant extra capital was needed because banks face other requirements, such as a counter-cyclical capital buffer, and changes that make them easier to close down – two reforms which Vickers said were no foolproof substitute for higher capital.
Under current plans, the deposit-taking divisions of banks must have the extra ring-fenced capital in place from 2019.
The reform is considered among the toughest of its kind in the world and has forced HSBC, Barclays, Lloyds and RBS to make internal changes.
Vickers’ comments also come at a time when the finance ministry wants a “new settlement” with banks, which has raised concerns among some lawmakers that banking rules are being watered down.
What Persistent Low Growth Might Mean
Interesting comments from Glenn Stevens in his address to Credit Suisse Global Markets Macro Conference New York. He discusses the impact of low growth on savers seeking yield, impacts on the broader economy, and the limits of monetary policy. He also mentions over-leveraged households, something which Australia knows all about!
Interest Rates and Savers
The first is the increasing concern that this world of ultra-low interest rates over a lengthy period is a big problem for savers. Here we are not talking about short-term trends. When everyone wants to save, the return to doing so will fall – that’s economics. In a cyclical sense that has to be expected, just as costs of borrowing rise when demand is strong.
The issue is when long rates are very low for a long time. In such a world, the whole set of assumptions embodied in retirement income plans will be called into question. Increasingly, we hear commentary about the difficulty – or impossibility – of defined-benefit pension plans making good on their promises with long-term rates of return so low. The fact that accounting rules and regulation now strongly incentivise trustees to hold bonds – at the lowest rates of return in human history – so as to minimise mark-to-market valuation changes over the short term only exacerbates the problem.
The problem is surely not confined to defined-benefit plans. Accumulation arrangements are still predicated on some set of assumptions about future income needs and returns. It may take longer but surely many of the owners of these funds are going to feel disappointment. The implicit promises – even if made only to themselves – about their retirement incomes are in danger of not being fulfilled. It is not a very daring prediction to say that these issues will loom ever larger over the years ahead.
Some critics lay these problems at the door of the central banks, whose policy actions have worked to lower long-term yields on financial assets. If it were really true that central bank policies were the only factor at work in very low long-term interest rates, while at the same time they were not helping growth, the critics might have a point.
But are central banks alone responsible for the decline in long-term interest rates? Real interest rates have fallen noticeably since 2007 – nearly a decade ago now. For there to be persistent effects on real interest rates as a result of central bank actions is perhaps not impossible, but seems contrary to everything we were taught when we studied economics. Monetary policy is not supposed to be able to affect real variables – like real interest rates – on a sustained basis. Presumably, changes in risk appetite, subdued growth and expectations that growth will continue to be subdued have also played a role in lowering real rates.
Interest Rates and Growth
This brings into focus the really critical question: what are the prospects for sustained growth in the future? Relatedly, what expectations about rates of return in the future are reasonable? The real economy needs to generate decent returns on the real capital stock that are then matched (risk-adjusted) by the yield on financial assets. The financial assets are, in the end, just paper claims on that flow of real returns – directly in the case of private sector obligations and indirectly for government obligations, which rely on being able to tax growing private incomes. If the real economy can’t perform to provide real returns to capital, there is nothing to back higher yields on financial assets. In that world, nominal and real yields on bonds would remain extremely low, the income being generated by those working with the capital stock would struggle to fund the benefits required by retirees through dividends and returns on bonds and bank deposits. Governments may not receive all the revenue they need to service their obligations. On the other hand, the stronger the prospects for long-term growth and good returns on the real capital stock, the smaller those problems will be and the more we can expect that, sooner or later, the yield on financial assets will be higher, in line with those real outcomes.
Which outcome will it be?
The more pessimistic are moving closer to the position of ‘secular stagnation’: that situation where the desire to save is so overwhelming and the apparent opportunities for profitable investment so weak, that real interest rates cannot equilibrate saving and investment for the system at positive rates of interest and full employment. The result is that the ex ante excess saving leads to a sustained below-full-employment equilibrium. The concept arose originally in the 1930s, but has recently been articulated by Lawrence Summers as a description of the current environment.[2]
I still find this a bit too pessimistic, because I struggle to accept that today, to an extent virtually unprecedented in modern history, ingenuity, technological development, entrepreneurial drive and opportunity for improvement are so weak – so unprecedentedly weak – and people’s desire to defer gratification so strong, that the equilibrium real rate of interest is actually going to be negative over an extended period.
What is undeniable, though, is that monetary policy alone hasn’t been, and isn’t, able to generate sustained growth to the extent people desire. Maybe this is simply the inevitable outcome after a period of excessive optimism and over‑leverage – an essentially cyclical explanation, where the cycle is a low‑frequency, financial one. Or maybe it is something more deep-seated and structural. That can all be debated. Either way, though, policies that encourage growth through means other than just ultra-cheap borrowing costs are surely needed.
It is often said, rightly, that policymakers should try to avoid unnecessary policy uncertainty. For central banks, this has meant trying to be clear about our objectives and our reaction functions – and what we will, or might, do in various states of the world. Maybe we need to be clearer about what we can’t do. Monetary solutions are for monetary problems. If there are other problems in the underlying working of the economy, central banks won’t be able to solve those.
Helicopter Money?
It is this recognition that purely monetary actions can go only so far, coupled with the need for some more growth and more inflation, that lies behind the recent discussion of ‘helicopter money’. In essence, this approach, were it to be attempted, would really be fiscal policy or a combined fiscal-monetary operation. It could involve unrequited transfers (gifts) to individuals’ bank accounts by the central bank – which diminishes the central bank’s net worth and so would require the acquiescence of its owner. Alternatively, it could involve direct funding of government spending by central bank finance – monetary-fiscal coordination.
There would be a host of practical issues to sort out in the ‘helicopter money’ approach. Other commentators have talked about these recently.
The main complication is surely that it would be a lot easier to start doing helicopter money than to stop, if history is any guide. Governments have found that a difficult decision to get right. That is, after all, how we got to the point where direct central bank financing of governments is frowned upon, or actually contrary to statute, in so many countries. It would be a very large step to overturn those taboos, which exist for good reason. The governance requirements in doing so would be, if not intractable, at least very complex. Desperate times call for desperate measures, perhaps. Are we that desperate?
Before we even got close to that point, one would have thought that for many governments today there must still be projects of an infrastructure kind that would, through conventional fiscal operations at current bond rates, offer returns comfortably above their cost of funding. Helicopter money is surely not needed in these cases. Questions may arise, in some jurisdictions at least, in the minds of citizens about the ‘soundness’ of such conventional policies. But if such questions arise about conventional fiscal actions, it seems unlikely that adding central bank financing to the mix would allay them.
It all Comes Back to Growth
But the very fact – extraordinary as it is – that such possibilities are being openly discussed by serious commentators reinforces the point that, while people find global growth outcomes still a bit disappointing, we are reaching the limits of monetary policy in boosting it. Central banks must of course do what they can, consistent with their mandates, and they continue to explore options. It is certainly clever to find ways of pushing the effective lower bound for interest rates down a bit further. It is inventive to find ways of lending more, at more generous terms, to the private sector.
But surely diminishing returns are setting in. My suspicion is that more and more people realise this. Maybe this has something to do with market confidence being easily rattled. There was a hint in the recent episode of the feeling that central banks didn’t have much left they could do, if things got worse.
So in the end we will collectively have to face up to the question of whether trend growth is lower and, if so, what is to be done about that. A few candidates might be advanced as contributing to such an outcome. Demographics is one. What we might label productivity pessimism – or is it realism? – along the lines of Robert Gordon’s views might be another. Others would point to excess debt in many jurisdictions as another.
If trend growth is lower and we can’t or don’t want to do anything about that, then expectations about future incomes, tax bases and so on will have to be reconfigured. People will need some explanation of why we have to accept that outcome. It may be that this reconfiguration is, in fact, what is happening. That would help to explain why ultra-low interest rates are not, apparently, as successful in boosting growth in demand as might have been expected. The future income against which people would borrow looks lower than it did, not to mention that the current income against which some already had borrowed has turned out to be lower than assumed.
Alternatively, even if we accept that demographic headwinds and the legacy of earlier problems make growth harder to achieve, perhaps we can re-double our efforts to address the things that may be unnecessarily restraining growth today and in the future. They might be things like:
- in some jurisdictions, inadequately capitalised banks
- over-leveraged firms or households
- poor incentives for risk-taking of the ‘right’ kind
- practices that unnecessarily impede productivity, or that slow down the re‑allocation of capital from old industries to new ones.
If we could engender a reasonable sense that future income prospects are brighter, that there is a good return to innovation and ‘real economy’ risk taking, and so on, then people might use low-cost funding for more productive purposes than just bidding up the prices of existing assets. Over time, the return on financial instruments could rise in line with returns in the real economy. Pension funds and insurers would be better able to meet their obligations. Governments would more easily service their debts. Citizens, having had some explanations as to why changes were necessary, would, in time, see some gains in their way of life, or at least some threats to their living standards abate. They would see less resort to very unorthodox policies, because there would be less need for them. And I can’t help thinking they would feel better about that.
Small Amount Credit Review Recommends Tighter Controls
The final report of the Review of Small Amount Credit Contracts (SACCs) has been released. A range of recommendations tighten regulation of short term small loans and consumer leases. Of note is the need to disclose the actual APR of the transaction, be it a small amount credit contract or consumer lease. In the latter case, the cost of the relevant household good must be disclosed.
The review panel provided the Final Report to the Government on 3 March 2016.
The review was silent on mandating better collection of transaction data so the true volume of loans could be recorded. As highlighted in the report accurate data is an issue.
Small Amount Credit Contracts (SACCs)
Recommendation 1 – Affordability – Extend the protected earnings amount regulation to cover SACCs provided to all consumers.
Reduce the cap on the total amount of all SACC repayments (including under the proposed SACC) from 20 per cent of the consumer’s gross income to 10 per cent of the consumer’s net (that is, after tax) income. Subject to these changes being accepted, retain the existing 20 per cent establishment fee and 4 per cent monthly fee maximums.
Recommendation 2 – Suitability – Remove the rebuttable presumption that a loan is presumed to be unsuitable if either the consumer is in default under another SACC, or in the 90-day period before the assessment, the consumer has had two or more other SACCs.
This recommendation is made on the condition that it is implemented together with Recommendation 1.
Recommendation 3 – Short term credit contracts – Maintain the existing ban on credit contracts with terms less than 15 days.
Recommendation 4 – Direct debit fees – Direct debit fees should be incorporated into the existing SACC fee cap.
Recommendation 5 – Equal repayments and sanction – In order to meet the definition of a SACC, the credit contract must have equal repayments over the life of the loan (noting that there may need to be limited exceptions to this rule). Where a contract does not meet this requirement the credit provider cannot charge more than an annual precent rate (APR) of 48 per cent.
Recommendation 6 – SACC database – A national database of SACCs should not be introduced at this stage. The major banks should be encouraged to participate in the comprehensive credit reporting regime at the earliest date.
Recommendation 7 – Early repayment – No 4 per cent monthly fee can be charged for a month after the SACC is discharged by its early repayment. If a consumer repays a SACC early, the credit provider under the SACC cannot charge the monthly fee in respect of any outstanding months of the original term of the SACC after the consumer has repaid the outstanding balance and those amounts should be deducted from the outstanding balance at the time it is paid.
Recommendation 8 – Unsolicited offers – SACC providers should be prevented from making unsolicited SACC offers to current or previous consumers.
Recommendation 9 – Referrals to other SACC providers – SACC providers should not receive a payment or any other benefit for a referral made to another SACC provider.
Recommendation 10 – Default fees – SACC providers should only be permitted to charge a default fee that represents their actual costs arising from a consumer defaulting on a SACC up to a maximum of $10 per week. The existing limitation of the amount recoverable in the event of default to twice the adjusted credit amount should be retained.
Consumer Leases
Recommendation 11 – Cap on cost to consumers – A cap on the total amount of the payments to be made under a consumer lease of household goods should be introduced. The cap should be a multiple of the Base Price of the goods, determined by adding 4 per cent of the Base Price for each whole month of the lease term to the amount of the Base Price. For a lease with a term of greater than 48 months, the term should be deemed to be 48 months for the purposes of the calculation of the cap.
Recommendation 12 – Base Price of goods – The Base Price for new goods should be the recommended retail price or the price agreed in store, where this price is below the recommended retail price. Further work should be done to define the Base Price for second hand goods.
Recommendation 13 – Add-on services and features – The cost (if any) of add-on services and features, apart from delivery, should be included in the cap. A separate one-off delivery fee should be permitted. That fee should be limited to the reasonable costs of delivery of the leased good which appropriately account for any cost savings if there is a bulk delivery of goods to an area.
Recommendation 14 – Consumer leases to which the cap applies – The cap should apply to all leases of household goods including electronic goods.
Further consultation should take place on whether the cap should apply to consumer leases of motor vehicles.
Recommendation 15 –Affordability – A protected earnings amount requirement be introduced for leases of household goods, whereby lessors cannot require consumers to pay more than 10 per cent of their net income in rental payments under consumer leases of household goods, so that the total amount of all rental payments (including under the proposed lease) cannot exceed 10 per cent of their net income in each payment period.
Recommendation 16 – Centrepay implementation – The Department of Human Services consider making the caps in Recommendations 11 and 15 mandatory as soon as practicable for lessors who utilise or seek to utilise the Centrepay system.
Recommendation 17 – Early termination fees – The maximum amount that a lessor can charge on termination of a consumer lease should be imposed by way of a formula or principles that provide an appropriate and reasonable estimate of the lessors’ losses from early repayment.
Recommendation 18 – Ban on the unsolicited marketing of consumer leases – There should be a prohibition on the unsolicited selling of consumer leases of household goods, addressing current unfair practices used to market these goods.
Combined recommendations
Recommendation 19 – Bank statements – Retain the obligation for SACC providers to obtain and consider 90 days of bank statements before providing a SACC, and introduce an equivalent obligation for lessors of household goods. Introduce a prohibition on using information obtained from bank statements for purposes other than compliance with responsible lending obligations. ASIC should continue its discussions with software providers, banking institutions and SACC providers with a view to ensuring that ePayment Code protections are retained where consumers provide their bank account log-in details in order for a SACC provider to comply with their obligation to obtain 90 days of bank statements, for responsible lending purposes.
Recommendation 20 – Documenting suitability assessments – Introduce a requirement that SACC providers and lessors under a consumer lease are required at the time the assessment is made to document in writing their assessment that a proposed contract or lease is suitable.
Recommendation 21 – Warning statements – Introduce a requirement for lessors under consumer leases of household goods to provide consumers with a warning statement, designed to assist consumers to make better decisions as to whether to enter into a consumer lease, including by informing consumers of the availability of alternatives to these leases. In relation to both the proposed warning statement for consumer leases of household goods and the current warning statement in respect of SACCs, provide ASIC with the power to modify the requirements for the statement (including the content and when the warning statement has to be provided) to maximise the impact on consumers.
Recommendation 22 – Disclosure – Introduce a requirement that SACC providers and lessors under a consumer lease of household goods be required to disclose the cost of their products as an APR. Introduce a requirement that lessors under a consumer lease of household goods be required to disclose the Base Price of the goods being leased, and the difference between the Base Price and the total payments under the lease.
The Government is also consulting on whether the recommendations relating to consumer leases should apply to all regulated consumer leases (including motor vehicles) rather than only leases of household goods, and how second hand goods should be treated.
Macroprudential stable funding requirement and monetary policy
The Reserve Bank NZ, just released a paper “A macroprudential stable funding requirement and monetary policy in a small open economy” which considers the impact of the Basel III net stable funding requirement, scheduled for adoption in 2018, requires banks to use a minimum share of long-term wholesale funding and deposits to fund their assets.
Central banks act as lenders of last resort to prevent liquidity pressures from becoming solvency problems. Liquidity provision by central banks, however, can lead to the problem of moral hazard. The availability of public liquidity reduces the incentive for banks to raise relatively expensive ‘stable’ funding such as retail deposits and long-term bonds, and leads banks to underinsure against refinancing risk. In periods when credit has grown rapidly, retail deposits have tended to grow more slowly, and banks have shifted toward less stable funding from short-term wholesale markets. The shift toward short- term wholesale funding increases the exposure of the banking system to refinancing risk, both by increasing rollover requirements and by lengthening intermediation chains through funding from other financial institutions. In response to the systemic liquidity stress experienced during the recent global financial crisis, extensive liquidity support was provided to banks, reinforcing incentives for moral hazard. Hence, stronger liquidity regulation has been proposed to increase banks’ self-insurance against liquidity risk.
The Basel III net stable funding requirement, scheduled for adoption in 2018, requires banks to use a minimum share of stable funding, in the form of long-term wholesale funding and deposits, to fund their assets. We introduce a stable funding requirement (SFR) into a small open economy model featuring a banking sector with richly-specified liabilities; deposits as well as short-term and long-term bonds. The SFR regulates the proportion of loans financed by the ‘stable’ component of the bank’s liabilities. The model is estimated for New Zealand, where a similar policy, the Core Funding Requirement, was adopted in 2010. A distinctive feature of the model is that it allows banks to issue short-term and long-term home currency-denominated debt overseas, in order to make loans in the small open economy.
We evaluate how the presence of the SFR alters monetary policy trade-offs between the volatility in inflation, and volatility in other variables such as output, interest rates and exchange rates. A higher SFR raises the share of long term foreign bonds on the banks’ balance-sheet and hence increases the economy’s exposure to shocks to the interest rate spread on long-term foreign debt. This in turn leads to macroeconomic volatility and hence worsens monetary policy trade-offs. However, since the SFR mainly affects the composition of bank funding rather than the cost, the SFR does not affect the transmission of other macroeconomic disturbances that do not affect the bank funding spread. Since bank funding spread disturbances have a negligible influence on the business cycle, the operation of monetary policy is little changed in the presence of the SFR. The additional macroeconomic volatility generated by the presence of the SFR can be diminished and monetary policy trade-offs can be improved if: (i) the central bank raises the interest rate to react systematically to increases in measures of credit growth in the economy and (ii) the SFR policy is varied over time to respond to credit growth.
Marketplace Lender Enthusiasm Confronts Market Realities – Fitch
After an extended period of rapid growth and increasing acceptance for marketplace lenders globally, several market dynamics are testing the business model’s long-term viability, Fitch Ratings says. These changes are forcing marketplace lenders to seek alternative funding sources, expand their product offerings, modify their underwriting approaches and address heightened regulatory scrutiny.
The challenges underscore the unproven nature of the marketplace lender business model – which was originally premised on funding loans primarily via retail investor demand – through the economic cycle. The extent to which marketplace lenders can navigate these challenges without adversely impacting their risk profiles and profitability will determine the sector’s long-term success.
A sustained period of historically low interest rates prompted an increased funding appetite among banks and other institutional investors for marketplace loans. As institutional demand waned in recent months, marketplace lenders began to seek alternative funding sources to sustain loan originations. For example, Social Finance (SoFi) recently launched a quasi-captive hedge fund purposed with investing in loans originated by SoFi as well as other marketplace lenders.
Some marketplace lenders also responded to reduced funding availability by raising loan pricing to attract funding; however, this reduces the competiveness of marketplace lenders’ lending rate (if the cost is passed to the borrower) or adversely impacts profitability (if the lender absorbs the cost). Passing higher funding costs through to borrowers is also harder to implement for lenders targeting higher quality borrowers.
The marketplace lender business model has yet to endure either a full interest rate cycle or credit cycle, so the resilience of current models under rising interest rates and/or rising credit losses is uncertain. Pockets of recent credit underperformance beyond initial expectations have likely contributed to the ongoing refinement of underwriting models, including further de-emphasizing of the use of traditional FICO scores in certain instances. Marketplace lenders are also exploring product expansion into adjacent lending products such as mortgages, small business loans, and autos, which Fitch views as tacit acknowledgement that business models, as currently constituted, may not have the diversity to flourish if core product growth is constrained.
Marketplace lenders’ rapid growth has attracted heightened regulation and legal risk (Madden v. Midland), which may force changes to loan pricing and risk sharing, as evidenced by recent changes implemented at Lending Club with respect to its relationship with WebBank. In this case, LendingClub gave up a portion of its revenue to WebBank in an effort to preserve its exemption from state-specific usury rate caps.
Fitch considers greater regulatory oversight to be inevitable with the distinctions between marketplace lenders and traditional lenders continuing to blur as marketplace lenders adapt their funding models to economic realities.
Several US federal and state regulators have begun to seek more information about the marketplace lending industry with the expectation of producing a more formal regulatory framework. LendingClub, Prosper Marketplace and Funding Circle established an industry trade group, the Marketplace Lending Association, to respond to regulatory scrutiny and establish certain industry operating standards.
Likewise, the regulatory environment has begun to evolve outside of the US. For example, regulators in China seem poised to tighten oversight of the industry given the rapid growth in loans originated in that region over the past few years and the degradation in credit performance that has ensued, driving some lenders out of business.
RBA Financial Stability Review Released Today; And All Is Well…ish
The RBA released the latest edition of the Financial Stability Review. Whilst they highlight the risks in emerging markets and higher bank funding costs, they argue local banks have limited exposure to these issues, households and business are financially sound and banks have tightened lending standards (as shown by lower LVRs and bigger affordability buffers) so predicted losses remain low, whilst profitability is strong. They are not concerned about high household debt ratios. The RBA also highlights the capital improvements which are in train. So overall they argue the financial sector is well positioned (though with a few issues to work though, for example, exposures to New Zealand Dairy and Property, Resource sector, property development, Insurance sector). They also say the tighter access to credit for households could pose near-term challenges in some medium- and high-density construction markets given the large volume of building activity that was started several years ago. They also suggest some foreign banks operating here could be under more pressure.
They examined Chinese buyers in the Australian Property Market.
Chinese investment in Australian residential and commercial property has increased significantly in recent years. This interest in property from Chinese households, institutional investors and developers is not unique to Australia; they are also active in the property markets of other countries, such as the United States, the United Kingdom, Canada and New Zealand.
The Australian banking system’s direct exposure to Chinese property investors and developers appears to be small. However, if Chinese demand were to decline significantly, that could weigh on domestic property prices and so lead to losses on the banks’ broader property-related exposures. Non-resident Chinese buyers own only a small portion of the Australian housing stock, but industry contacts suggest that they account for a significant and increasing share of purchases. These purchases are largely concentrated in off-the-plan apartments (especially in Sydney and Melbourne), in part because all foreign buyers, other than temporary residents, are generally restricted to purchasing newly constructed dwellings. Consistent with observations by industry contacts, the limited and partial data available from the Foreign Investment Review Board (FIRB) suggest that approvals for all non-residents applying to purchase residential property have increased substantially of late. The majority of these approvals are for new dwellings in New South Wales and Victoria. China is the largest source of approved investment in (residential and commercial) real estate and its share of total approvals is growing, but it still only accounts for a small fraction of overall market activity.
Nonetheless, if a significant subset of buyers reduce their demand sharply, this can weigh on housing prices, and Chinese buyers are no exception to this given their growing importance in segments of the Australian market. Such a reduction in housing demand could result from a number of sources, including:
- A sharp economic slowdown in China that lowers Chinese households’ income and wealth. Any accompanying depreciation of the renminbi against the Australian dollar could further reduce their capacity to invest in Australian housing. In the extreme, Chinese investors may need to sell some of their existing holdings of Australian property to cover a deteriorating financial position at home. A macroeconomic downturn in China could also be expected to have knock-on effects on other countries in the region, which could also affect those countries’ residents’ capacity and appetite to invest in Australian property. On the other hand, if economic prospects in China deteriorate this could make investment abroad, including in Australia, more attractive and result in an increase in demand for Australian property.
- A further tightening of capital controls by the Chinese authorities that restricts the ability of Chinese households to invest abroad.
- A domestic policy action or other event that lessens Australia’s appeal or accessibility as a migration destination, including for study purposes. Industry contacts suggest that in addition to wealth diversification, many Chinese purchases are dwellings for possible future migration, housing for children studying in Australia or rental accommodation targeted at foreign students. If so, this demand could be expected to be fairly resilient to shorterterm fluctuations in conditions in China or developments in the domestic property market, but more sensitive to changes in migration or education policy.
A substantial reduction in Chinese demand would likely weigh most heavily on the apartment markets of inner-city Melbourne and parts of Sydney, not only because Chinese buyers are particularly prevalent in these segments but also because other factors would reinforce any initial fall in prices. These include the large recent expansion in supply in these areas as well as the practice of buying off the-plan, which increases the risk of price declines should a large volume of apartments return to the market if the original purchases fail to settle.
The Australian banking system has little direct exposure to Chinese investors. Australian owned banks engage in some lending to foreign households to purchase Australian property, but the amounts are small relative to their mortgage books. Australian-owned banks also have tighter lending standards for non-residents than domestic borrowers, such as lower maximum loan-to-valuation ratios, because it is harder to verify these borrowers’ income and other details, and because the banks have less recourse to these borrowers’ other assets should they default on the mortgage.
Australian branches of Chinese-owned banks appear to be more willing to lend to Chinese investors because they are often in a better position to assess these borrowers’ creditworthiness, particularly where they have an existing relationship. Nonetheless, although the direct exposures are small, if a reduction in Chinese demand did weigh on housing prices this could affect banks’ broader mortgage books to some extent.
Whats Really Going On With Investment Housing Lending?
The ABS data on lending finance was issued on Wednesday, and the seasonally adjusted numbers caught the headlines. Housing finance was up 1.7% month on month, and commercial finance was up 5.6%. However, the seasonally adjusted numbers have lots of noise in the data, we we think they obscure what is really going on. So, first we look at the trend data. Overall credit flows fell by 0.9% in the month. Within that secured housing fell 0.6%, whilst secured lending for alternations and additions rose 0.5%. Revolving credit (mainly credit cards) fell 1.7% as households continues to pay off the Christmas binge, but fixed loans rose 0.5%. Commercial fixed loans (which include housing investment loans), fell 1.6%. However, the value of housing investment loans were line ball from last month, so the fall was from other commercial sectors, which is not good.
As a result, we see from the summary chart that the proportion of fix commercial lending NET of housing investment fell, from 28.7% to 28.2%, so in trend terms, lending for commercial purposes continued to fall. Assuming that lending is correlated to prospective economic growth, this is bad news.
On the other hand, lending for investment housing was still very present, and lifted to 35.3% of all secured housing loans. Investment lending still has momentum. Also, now we are seeing more households deciding to stay put and renovate. We expect lending demand for renovations to be strong in coming months.
The other piece of data which is important is the state lending footprint. Some made much of the apparent fall in investment lending in NSW, but taking the original data (there are no trend or seasonally adjusted series), and using a rolling average over 3 months, we see a different story. The best way to look at this is to compare lending for investment housing (sum of new construction and purchase of existing dwellings for rental), compared with all commercial lending. When we look at the series, we do see a small fall in NSW, though with an upward inflection in the latest data. But we see that NSW has a lower relative share of housing investment loans compared with QLD and WA. In fact relatively there has been a greater proportion of investment loans written in these states for since 2011. VIC is also lower, though above NSW. So, the story about the great fall in housing investment momentum in NSW is over done. On the other hand, we should be more concerned about the ongoing investment momentum in QLD and WA, where house prices are set to ease, and mining re-balancing is most at work. We think the risks are higher here.
We are still not seeing sustained commercial investments which are required to drive true economic growth. Housing is still doing too much of the heavy lifting, with household debt as high as it has ever been.