Social Trends – Page 133 – Digital Finance Analytics (DFA) Blog

Half Of Pre-Retirees Risk Significant Shortfalls

Almost half of Australians between the ages of 50 and 70 are at risk of falling short of a comfortable retirement, according to new research released by MLC.

The research explored the thoughts and habits of the “forgotten” low super balance Boomers, and revealed nearly half (43 per cent) of those surveyed admitted to having a superannuation balance of less than $100,000.

Additionally, 33 per cent of this age group reported having $50,000 or less in their super account, falling extremely short of what is recommended a single retiree needs for a comfortable retirement (over $545,000).

Lara Bourguignon, General Manager of Customer Experience, Superannuation at MLC, believes that all Australians should enjoy retirement – regardless of their financial situation.

“Australia has a high level of poverty among retirees, and we believe that super is one of the greatest tools we have to change this.”

“While these results are concerning, we want to remind people in this age group that it’s not too late for them to take action and better understand their holistic wealth position as they prepare for retirement.”

Ms Bourguignon said there are a number of steps Australians can take to maximise their super balance in their final years of work, and to structure their portfolios to make the most of what they do have when they’re in retirement.

“For example, we know some of the people in this age group have other assets such as property in their name beyond super, which is an important factor for them to consider when planning for retirement.”

“If they don’t have other assets, engaging with their super fund may prove to be a cost effective way for them to access advice in lieu of seeing a financial adviser,” Ms Bourguignon said.

Of those with a retirement saving of under $100,000, the research also revealed 42 per cent only became concerned about the balance of their retirement savings in their 50s, while over 30 per cent admitted they never checked their super balance.

“Sticking your head in the sand will often lead to unnecessary stress”.

How governments have widened the gap between generations in home ownership

From The Conversation.

Various government policies have fuelled the demand for housing over time, expanding the wealth of older home owners and pushing it further and further beyond the reach of young would-be home buyers. A new study highlights this divide between millennials and their boomer parents.

The study is part of a Committee of Economic Development of Australia (CEDA) report called Housing Australia. It compares trends in property ownership across age groups over a period of three decades.

Between 1982 and 2013, the share of home owners among 25-34 year olds shrunk the most, by more than 20%. On the other hand, the share of home owners among those aged 65+ years has risen slightly.

The rate of renting has spiralled among young people. By 2013, renting had outstripped home ownership among 25-34 year olds.

Same policies, different impacts on generations

There is undoubtedly a growing intergenerational divide in access to the housing market. The timing of policy reforms has been a major driver of this widening housing wealth gap.

Negative gearing has long advantaged property investors, potentially crowding out aspiring first home buyers. While negative gearing was briefly quarantined in 1985, this was repealed after just two years.

The appeal of negative gearing grew as financial deregulation spread rapidly during the 70s and 80s. This deregulation widened access to mortgage finance, but also pushed real property prices to ever higher levels.

In 1999, the Ralph review paved the way for the reform of capital gains tax on investment properties. Instead of taxing real capital gains at investors’ marginal income tax rates, only 50% of capital gains were taxed from 1999 onwards, albeit at nominal values.

The move, designed to promote investment activity, actually aggravated housing market volatility. The confluence of negative gearing benefits and the capital gains tax discount encouraged investors to go into more debt to finance buying property, taxed at discounted rates. The First Home Owners Grant, introduced in 2000, was another lever that increased demand. In the face of land supply constraints, these sorts of subsidies were likely to result in rising house prices.

Other policy reforms, while not directly housing related, have also affected young people’s opportunities to accumulate wealth.

The Higher Education Contribution Scheme (HECS) was introduced in 1989, at a time when many Gen X’s were entering tertiary education. This ended access to the free education that their boomer parents enjoyed.

HECS parameters were tightened over time. And in 1997, HECS contribution rates rose for new students and repayment thresholds were reduced.

Of course, the 1992 introduction of the superannuation guarantee would have boosted Gen X’s retirement savings relative to boomers. However, these savings are not accessible till the compulsory preservation age, so can’t be used now to buy a house.

All these policies have clearly had varying generational impacts, adversely affecting home purchase opportunities for younger generations while delivering significant wealth expansion to older home owners.

An intergenerational housing policy lens

A new housing landscape has emerged in recent years. It is marked by precarious home ownership and long-term renting for young people.

It’s also dominated by a growing wealth chasm – not just between the young and old – but also between young people who have access to wealth transfers from affluent parents and those who do not.

The majority of housing related policies do not consider issues of equity across generations. There are currently very few examples of potential housing reforms that can benefit multiple generations.

However, there is one policy that could – the abolition of stamp duties. It would remove a significant barrier to downsizing by seniors.

The equity released from downsizing would boost retirement incomes for seniors, while freeing up more housing space for young growing families. Negative impacts on revenue flowing to government could be mitigated by a simultaneous implementation of a broad based land tax. This would in turn push down house prices.

As life expectancies increase, the need for governments to take into account policy impact on different generations is critical. On the other hand, policies that take a short-term view will only worsen intergenerational tensions and entrench property ownership as a marker of distinction between the “haves” and “have nots” in Australia.

Author: Rachel Ong, Deputy Director, Bankwest Curtin Economics Centre, Curtin University

The Future: Save More, Work Longer

According to the IMF Blog, Young adults in advanced economies must take steps to increase their retirement income security. Younger generations will have to work longer and save more for retirement.

But with flat income, high debt, and potentially rising interest rates, saving we think may be an impossible task, which will redefine the concept of retirement altogether.

Public pensions have played a crucial role in ensuring retirement income security over the past few decades. But for the millennial generation coming of working age now, the prospect is that public pensions won’t provide as large a safety net as they did to earlier generations. As a result, millennials should take steps to supplement their retirement income.

Pensions and other types of public transfers have long been an important source of income for the elderly, accounting for more than 60 percent of their income in countries that are members of the Organisation for Economic Co-operation and Development (OECD). Pensions also reduce poverty. Without them, poverty rates among those over 65 also would be much higher in advanced economies.

Pressure on pensions

But pensions are also costly to provide. Government spending on pensions has been increasing in advanced economies from an average of 4 percent of GDP in 1970 to close to 9 percent in 2015—largely reflecting population aging.

Population aging puts pressure on pension systems by increasing the ratio of elderly beneficiaries to younger workers, who typically contribute to funding these benefits. The pressure on retirement systems is exacerbated by increasing longevity—life expectancy at age 65 is projected to increase by about one year a decade.

To deal with the costs of aging, many countries have initiated significant pension reforms, aiming largely at containing the growth in the number of pensioners—typically by increasing retirement ages or tightening eligibility rules—and reducing the size of pensions, usually by adjusting benefit formulas. Since the 1980s, public pension expenditure per elderly person as a percent of income per capita—the so-called economic replacement rate—has been about 35 percent. But that replacement rate is projected to decline to less than 20 percent by 2060.

This means that younger generations will have to work longer and save more for retirement to achieve replacement rates similar to those of today’s retirees.

Working longer

To close the gap in the economic replacement rate relative to today’s retirees, one option for younger individuals is to lengthen their productive work lives. For those born between 1990 and 2009, who will start to retire in 2055, increasing retirement ages by five years—from today’s average of 63 to 68 in 2060—would close half of the gap relative to today’s retirees. A longer work life can be justified by increased longevity. But prolonging work lives also has many benefits. It enhances long-term economic growth and helps governments’ ability to sustain tax and spending policies. Working longer can also help people maintain their physical, mental, and cognitive health. However, efforts to promote longer work lives should be accompanied by adequate provisions to protect the poor, whose life expectancy tends to be shorter than average.

Saving more

Simulations suggest that if those born between 1990 and 2009 put aside about 6 percent of their earnings each year, they would close half of the gap in economic replacement rate relative to today’s retirees. In practice, relying on people’s private savings for retirement requires a hard-to-achieve mix of fortune and savvy. First, individuals need continuous and stable earnings over their careers to be able to save sufficient amounts. Second, workers would have to be able to decide how much to put aside each year and how to invest their savings. Third, the risks from uncertain or low returns are borne by individuals. Finally, workers would have to decide how fast to consume their savings during retirement. These are all complex decisions, and people can make mistakes at each step along the way.

Time to cope

For younger generations, acting early is crucial to ensure retirement income security, especially because longevity gains are projected to continue. As millennials start to enter the workforce, retirement might be the last thing on their mind. But with many governments retrenching their role in providing retirement income, younger workers need to work longer and step up their retirement savings.

Governments can make it easier for individuals to remain in the workforce at older ages by reviewing taxes and benefits that might favor early retirement. Nudges to encourage workers to save can also help, for example by automatically enrolling them in private retirement saving plans. For example, starting in 2018, the United Kingdom will require employers to automatically enroll workers in a pension program. Boosting financial literacy and making the workplace more friendly to older workers can also be part of the solution.

The good news for younger workers is that retirement is some four decades away, allowing time to plan for longer careers and to put money aside for later. But they must start now.

Meet The Eleventh Largest and Totally Unregulated Bank In Australia

More households are only able to purchase residential property with help from parents – the Bank of Mum and Dad. This has become a critical factor in helping first time buyers in particular break into the very expensive property market, especially as lenders tighten their underwriting standards.

But here is an astonishing fact – the Bank of Mum and Dad, on our latest estimate, is the eleventh largest lender in Australia, ahead of AMP Bank, HSBC and most of the community banks and mutuals. We estimate at least $16 billion is outstanding with the Bank of Mum and Dad, and it is growing fast.

The average advance to a prospective purchaser is now $88,096, and this continues to rise.

More than half of first time buyers need help from the Bank of Mum and Dad, either a cash gift or loan, or other help such as paying stamp duty, helping with mortgage repayments or child care costs. This is because of the equity held by those owning property, which is accessible when needed. But it does reinforce the inter-generational issues, and the risks in the market.

We wonder how many lenders check specifically to see if the saved deposit a prospective first time buyer has is a gift or private loan.

The mix of loans is interesting in that we see a relative rise in the number of owner occupied transactions where the Bank of Mum and Dad is active. In 2015, more investor loans were funded than owner occupied loans, that has reversed now.

Across the states, the relative proportion in VIC is growing, although NSW still has the largest number of loans. But the Bank of Mum and Dad is active is all states and territories.

Three points worth considering.

First, new buyers are ever more reliant on assistance from parents, but this creates inter-generation pressure with older home owners perhaps giving away value which should be part of their retirement nest egg, and younger buyers holding additional debt obligations below the water line. All caused by our silly property market, as Four Corners discussed. Those who do not have “wealthy” parents have little chance of entering the market, another factor in the inequality debate.

Second, this is of course totally (rightly) unregulated, but suggests that overall housing debt is even higher than might be thought from the official statistics. Often the arrangements are not formalised, and this can lead to issues down the track. Bank underwriting standards need to take account of this phenomenon.

Third our analysis suggests that households who receive such assistance are more likely to get into financial difficulty later, because they have not had the discipline of saving and so over-reach property wise.

Just one more element to consider when trying to understand the complex property finance sector.

Why investor-driven urban density is inevitably linked to disadvantage

From The Conversation.

The densification of Australian cities has been heralded as a boon for housing choice and diversity. The up-beat promotion of “the swing to urban living” by one of Australia’s leading developer lobby groups epitomises the rhetoric around this seismic shift in housing.

Glossy advertisements for luxury living in our city centres and suburbs adorn the property pages of our newspapers.

Brochures boast of breathtaking city views from uppers storeys and gush about amenity, lifestyle and “liveability” – often touting the benefits of adjacent public infrastructure investments (but please don’t mention “value sharing”).

Depictions of attractive younger people, occasionally clutching a smiling infant, are prominent as the image of all things new, urban and desirable.

Long gone are the days when the manifestations of property marketeers’ imaginations were restricted to images of low-density master-planned estates on the urban fringe. We hardly ever hear about these nowadays.

There’s truth in the claims that housing choice and diversity have indeed widened in the last few decades as a result. The statistics clearly show a much greater spread of dwelling options in our cities.

The rise and rise of the apartment block

Apartments now account for 28% of housing in Sydney and 15% in Melbourne. As the maps below show, most recent growth in apartment stock is clearly in and around the inner city. Yet even the more distant suburbs have had an increase in higher-density residential development.
Changes in the number of flats and apartments, 2011 to 2016, in Sydney (above) and Melbourne (below). Data: ABS Census 2011, 2016, Author provided
Data: ABS Census 2011, 2016, Author provided
For many, inner-city apartment living is clearly a preferred choice for the stage in their life when an upcoming, “vibrant” neighbourhood is attractive. High-density urban renewal has been a boon for hipsters and students alike.

But the issue of choice needs to be unpacked carefully. For many others, the “swing to urban living” is more of a necessity.

True, the surge in apartment building has put many properties onto the market to rent or buy that are clearly cheaper than houses in the same suburb. From that point of view, they have added to the affordability of these neighbourhoods.

However, affordable to whom is an open question. At A$850,000 and upwards for a standard two-bedder in Waterloo, South Sydney, and $500,000 or more in Melbourne’s Docklands for a similar property, these are not exactly a cheap option for anyone on a low income.

But other than in the prestige areas where higher-income downsizers and pied-à-terre owners can be enticed to buy in some comfort, much of what is being built is straightforward “investor grade product” – flats built to attract the burgeoning investment market.

It can be argued that the investor has always been a major target of apartment developers, even in the 1960s and 1970s when strata units became common, particularly in Sydney. But it is even more so today.

Despite the clamour to control overseas investors perceived to be flooding the market, the bulk of investors are home grown. We don’t need to rehearse the debates on the factors that have fuelled this splurge, but clearly the development industry has been savvy to the possibilities of this market.

In the last decade, backed by state planning authorities and politicians desperate to claim they have “solved” housing affordability by letting apartment building rip, developers have got involved on an unprecedented scale. The figures bear this out: in 2016, for the first time, Australia built more apartments than houses. The majority end up for rent.

Problematic products with too few protections

In the rush, we, the housing consumer, have been offered a motley range of new housing with a series of escalating problems. Leaving aside amateur management by owners’ bodies in charge of multi-million-dollar assets, problems of short-term holiday lettings and neighbour disputes, there are more serious concerns over build quality, defective materials and fire compliance.

The apartment market has been left wide open for poor-quality outcomes by building industry deregulation. This includes:

moves toward complying development approval for high-rise;

self-certification of building components;

complex design and non-traditional building methods;

relaxation of defect rectification requirements;

long chains of sub-contractors;

poor oversight by local planners and authorities; and

cheap or non-compliant fittings and finishes.

Plus there’s the rush to get buildings up and sold off. Not to mention fly-by-night “phoenix” developers who vanish as soon as the last flat is occupied, never to be found when the defects bills come in.

The lack of consumer protection in this market is astounding. The average toaster comes with more consumer protection – at least you can get your money back if the product fails.

‘Vertical slums’ in the making

These chickens will surely come home to roost in the lower end of the market, which will never attract the wealthy empty-nesters or cashed-up young professionals with the resources to ensure quality outcomes.

In Melbourne, space and design standards, including windowless bedrooms, have come under critical scrutiny, as has site cramming. Tall apartment blocks stand cheek-by-jowl in overdeveloped inner-city precincts.

At least New South Wales has State Environmental Planning Policy 65, which regulates space and amenity standards, and the BASIX environmental standard to prevent the more egregious practices.

But people are most likely to confront the problems of density in the many thousands of new units adorning precincts around suburban rail stations and town centres. These have been built under the uncertain logic of “transport-orientated development”, often replacing light industrial or secondary commercial development.

These developments attract a mixed community of lower-income renters. Many are recently arrived immigrants and marginal home buyers – often first-timers. Many have young children, as these units are the only option for young families to buy or rent in otherwise unaffordable markets. Overall, though, renters predominate.

What will be the trajectory of these blocks, once the gloss wears off and those who can move on do so? You only have to look at the previous generation of suburban walk-up blocks in these areas to find the answer.

Far from bastions of gentrification, the large multi-unit buildings in less prestigious locations will drift inexorably into the lower reaches of the private rental market.

Town centres like Liverpool, Fairfield, Auburn, Bankstown and Blacktown in Sydney point the way. The cracks in the density juggernaut are already showing in many of the more recently built blocks in these areas – literally, in many cases.

This inexorable logic of the market will create suburban concentrations of lower-income households on a scale hitherto experienced only in the legacy inner-city high-rise public housing estates.

With the latter being systematically cleared away, the formation of vertical slums of the future owned by the massed ranks of unaccountable, profit-driven investor landlords is a racing certainty. The consequences are all too easy to imagine.

The call for greater regulation of apartment, planning, design and construction is being heard in some quarters. The 2015 NSW Independent Review of the Building Professionals Act highlights these concerns.

But don’t hold your breath for rapid reform. No-one wants to kill the goose that’s laying so many golden eggs for the development industry and government alike – especially in inflated stamp-duty receipts.

The market has a habit of self-regulating on supply. Evidence of a marked downturn in apartment building is a clear sign of that. But don’t expect the market to self-regulate on quality, at least with the current highly fragmented, confusing (not least to builders and bureaucrats), under-resourced and largely unpoliced regulatory system.

The legacy of this entirely avoidable crisis is completely predictable, but will be for future generations to pick up

Author: Bill Randolph, Director, City Futures – Faculty Leadership, City Futures Research Centre, Urban Analytics and City Data, Infrastructure in the Built Environment, UNSW

This is why apartment living is different for the poor

From The Conversation.

There’s been a lot of talk about apartment living of late. Whether it’s millennials who can’t afford to buy a house, downsizers making a lifestyle change, owner-occupiers struggling to get defective buildings fixed, or foreign investors buying into new development, there’s no shortage of opinions and interest.

Except for one group: lower-income and vulnerable residents.

In Greater Sydney, the latest census data show that almost one in five households (17%) living in apartments and townhouses have weekly household incomes of less than A$649.

Among this group the largest sub-group (36%) live in private rental housing. That’s more than 72,000 households living on $649 or less per week in a housing market where average weekly rents for apartments are $550.

Our research for Shelter NSW identifies multiple challenges such households face.

Why does this matter?

It matters because some things about apartment and townhouse living are fundamentally different to living in a house. These differences have particular impacts on lower-income and vulnerable people living in higher-density housing.

The significant differences include:

You live closer to your neighbours, so it’s more likely you’ll see, hear or meet them.

You share services and spaces with neighbours, from gardens to laundries to lifts.

You have to co-operate with other residents and owners to manage and pay for building operation and upkeep.

If you live in a private apartment building then the fact that a large proportion of apartments are sold to investors and rented out will likely have three key impacts on you:

Developers often cater for investors when designing new apartment buildings, so you will likely find a limited variation in apartment designs and sizes available.

Resident turnover in your building may be high, as private renters move more frequently.

Tensions between owner-occupiers and investor-owners may result in disagreements and disputes over budgeting and maintenance.

While these unique aspects of higher-density living can be tricky for anyone, they present particular challenges for lower-income and vulnerable residents. They tend to have less choice about their living arrangements, so they can’t up and move to better-designed, constructed and managed properties if things aren’t working out.

Building flaws affects some residents in particular

Poor building quality is one of the major issues in high-density development in Australia. The problems relate to design, defects and maintenance.

The design issues include noise disturbances as a result of poor design, inadequate solar access and cross ventilation, the availability and flexibility of shared spaces, and safety and security considerations.

Another issue is design that fails to help meet the needs of particular groups (such as people with a disability, and families with children).

Beyond design, the construction quality of higher-density developments is a major issue in Australia. Key concerns include the quantity and severity of building defects, as well as the difficulties owners face having defects fixed.

Among the problems are quality of workmanship, management of construction, private certification, limited warranties and the often-prohibitive cost of legal action.

As with poor design, lower-income households are particularly susceptible to construction issues. This is because there are more incentives to cut corners when constructing more affordable housing. Examples include rushing jobs, hiring cheaper but less experienced tradespeople, or using substandard materials.

Once residents move in, negotiating to fix defects is particularly difficult for private renters, as they typically must go through the real estate agent or landlord. This means renters may be stuck with unsatisfactory living conditions.

Lower-income renters are also likely to be over-represented in poorly maintained buildings, as these are usually cheaper to rent. Compared to a detached house, maintenance in higher-density properties is complicated by the complexity of the buildings themselves and the governance structures.

As a result, required maintenance work is often not carried out, or is reactive rather than proactive. This is especially true in buildings occupied by lower-income renters with no direct recourse to the strata committee. They often cannot afford to move and may fear retaliatory rent increases if they report maintenance issues.

Social relations can be challenging

Neighbour disputes happen everywhere, but evidence suggests disputes are more common in areas with more lower-income and vulnerable residents and with more apartments.

Common causes of neighbour conflict in higher-density housing reflect different expectations about noise levels, parking practices, or spending on maintenance and improvements.

Neighbour disputes can have significant impacts on health. This potentially counteracts the health benefits associated with the walkable nature of many higher-density neighbourhoods.
When disputes arise, the number of stakeholders involved complicates efforts to find a resolution. They might include renters, resident owners, investor owners, building managers, strata managers and strata committee members.

Research with strata residents in New South Wales shows residents find formal dispute resolution mechanisms complex and slow. Most disputes are resolved informally.

Lower-income residents, and renters in particular, are likely to have less influence over the outcomes of such processes.

Fostering positive neighbour relations can be more difficult where resident turnover is high, such as in buildings dominated by private renters. It is also more difficult in poorly designed buildings without quality shared spaces.

New norm promotes inequity

Apartment living is the new norm in Australia. As the nursery rhyme says, when it’s good it’s very, very good, but when it’s bad it’s horrid. If these homes are poorly designed, poorly built, poorly maintained or poorly managed, they are poor places to live.

The market-led housing model that underpins Australia’s compact city policies has meant that people with less money get a poorer product. Few planners or politicians have adequately acknowledged these inequities.

Authors: Hazel Easthope, Senior Research Fellow, City Futures Research Centre, UNSW; Laura Crommelin, Research Associate, City Futures Research Centre, UNSW; Laurence Troy, Research Fellow, City Futures Research Centre, UNSW

Another Perspective On Debt

We had significant reaction to yesterday’s post on the “normal” status of high household debt. So today we take the argument further using data from the RBA Household Balance Sheet series (E1) and the recent ABS data on income growth.

The traditional argument trotted out is that household wealth is greater than ever, this despite low income growth and rising debt. But of course wealth is significantly linked to home prices, which in turn is linked to debt, so this is a circular argument. You get a different perspective by looking at some additional trends.

But lets start with the asset side of the ledger. We have base-lined the data series from 1999. Since then, superannuation has grown by 181.2%, and at the fastest rate. But it is arguably the least accessible asset class.

Residential property values rose 160.2% over the same period, and grew significantly faster than equities which achieved 135.8% growth, no wonder people want to invest in property – the capital returns have been significantly more robust. Deposit savings grew 159.1% (but the savings ratio has been declining recently). Overall household net worth rose 151.2%. So the story about households being more affluent can be supported on this view of the data. But it is myopic.

The chart below tracks overall household debt, house prices, household net worth, income growth and the growth in the number of residential properties.

Overall household debt rose 161.9%, a growth rate which is higher than residential property values, at 160.2% and above overall household net worth at 151.2%.

But look at the growth in income, which is 60.5%, under half the asset growth. OK, interest rates are lower now, but this increase in leverage is phenomenal – and explains the “debt is normal” findings from our focus groups. I accept debt is not equally spread across the population, but there are significant pockets of high borrowing, as can be seen from our mortgage stress analysis – and its not just among battling urban fringe mortgage holders.

Finally, it is worth noting the growth in the number of residential properties rose by just 29.8% over the same period. So the average value of individual properties have increased significantly. On paper.

To me this highlights we have learned nothing from the GFC, our appetite for debt, supported by the low interest rate monetary policy, significant tax breaks, and salted by population growth has created a debt monster, which has the capacity to consume many if interest rates were to rise towards more normal levels. Unlike Governments, household debt has to be repaid, eventually.

This data series shows clearly the relationship between more debt and home prices, they feed of each other, and this explains why the banks have enjoyed such strong balance sheet growth. But the impact on households is profound, and long term.

Our current attitude to debt will be destructive eventually.

Is This Amount of Debt “Normal”?

As part of our household survey we had the chance to discuss household debt in our focus group. We had selected participants with large debt burdens, because we wanted to understand better what was driving this behaviour. It was mixed group, with households represented between 20 and 60 years, from multiple locations. The RBA data showing high household debt prompted the research.

In the session, a number of themes emerged. Yes we got the story about incomes not rising, costs going up and big mortgages; as expected. But there was another theme that struck home to the facilitators.

It is this. Around two thirds of the households in the session had a basic assumption that high debt levels were normal. They had often accumulated debts through their education, when they bought a house, and running credit cards. Even more interestingly, their concern from a cash flow perspective was about servicing the debts, not repaying them.

One quote which struck home was “once I am dead, my debts are cancelled”, I just keep borrowing til then.

Wow! Debt, it seems has become part of the furniture, and will remain a spectre at the feast throughout their lifetime. The banks will be happy!

But this got me thinking about the implications of this observation. If households are making debt decisions based on just debt servicing, what does that say about their future cash flow in a low income growth, potentially rising interest rate environment? Is this normal behaviour now? Has financial literacy failed, or is there a new logic in town?

If there is, then I have to ask – am I out of kilter in believing that debt can be useful, but it should be paid down as soon as possible, and that borrowing is the exception, not the rule. Or is the new normal to be saddled with high debt, and live with it? For ever?

The remaining one third, by the way, were more conscious of the need to repay, and were surprised by the majority view in the room.

No wonder households are more highly in debt than ever as the recent RBA data shows. But what I am getting at are the cultural norms which now exist. As a result, lenders will continue to have a field day, but what are the true economic and social costs of this phenomenon?

We hope to do more research on this. Watch this space.

Aging Japan Puts a Strain on the Financial System

From The IMFBlog.

Japan’s population is shrinking and getting older, posing challenges to the nation’s financial system. How Japan copes could guide other advanced economies in Asia and Europe that are grappling with the same trends but are at an earlier phase of similar demographic developments.

A declining and aging population weighs on growth and interest rates. This puts pressure on profits of banks and insurance companies. Judging how these shifts affect financial firms was part of the IMF’s Financial Sector Assessment Program for Japan, the world’s third-largest economy. The program is a comprehensive and in-depth assessment of a country’s financial sector. It analyzes the resilience of the financial sector, the quality of the regulatory and supervisory framework, and the capacity to manage and resolve financial crises.

An aging population is also likely to reduce the role of banks in the financial system. With increasing longevity, the demand for longer-term securities rises (since people save more for longer retirements). This results in a flatter yield curve–and banks typically make money by borrowing at low short-term rates and lending at higher longer-term ones. In line with this intuition, analyses of data from 34 countries around the world confirm that the size of the banking sector relative to nonbank financial intermediaries is negatively associated with aging. About 40 percent of the increase in the size of market finance in Japan since 1990 can be explained by aging.

Smaller banks that rely on lending to local markets are particularly vulnerable, since they face less demand from households and firms. Older households still need banking services for transaction purposes, which means that lending will likely fall much faster than deposits. As a result, over the next two decades some regional banks could see their loan-to-deposit ratios fall by 40 percentage points.

In response to profitability problems, banks are also engaging in riskier forms of lending and investment as they search for yield. They have been making more real estate loans, helping to drive up housing prices in some areas despite overall population shrinkage. Condominium prices appear to be moderately overvalued in Tokyo, Osaka, and several outer regions. Banks have also been investing more in securities in countries where economic growth is faster than Japan’s.

Life insurance companies are also facing increasing pressure. They have been putting more money into riskier overseas markets to get the yield needed to meet interest guarantees.

The problem is that many banks and insurers still need to develop the capacity to manage the risks associated with these new types of investments.

Consequently, stress tests suggest that market risks are increasing and that there are some vulnerabilities among regional and shinkin (cooperative) banks and life insurers. Although bank liquidity is generally ample, some of the regional banks are exposed to risks in foreign-currency funding.

The Bank of Japan has had to adapt its monetary policy to low “natural” rates in the economy and sought to stimulate demand by monetary easing. In this context, it had to resort to large-scale asset purchases. These purchases in turn, have put a strain on markets. The level of liquidity—how easily and quickly investors can buy and sell securities—in Japanese government bond markets seems to have been adversely affected by the central bank’s purchases. Moreover, the resilience of government bond market liquidity also seems to have declined as the share of Bank of Japan holdings has increased.

Japan’s financial system has so far remained stable. But there are steps policymakers can take to ensure that it remains sound as society ages and slow growth continues:

Supervisors need to modernize supervision to keep pace with the more sophisticated activities emerging across banks, insurers, and securities firms. Tailoring capital requirements to individual bank risk profiles and implementing a framework that appropriately recognizes the financial conditions of insurers would be key.

Corporate governance needs to be strengthened across the banking and insurance sectors to manage new risk taking.

The macroprudential framework could be further strengthened to better identify and address any buildup of systemic risks.

Some (in particular regional) banks will feel increased pressure, so they should be encouraged to take timely action in response to viability concerns.

Regional banks should be encouraged to consider augmenting fee-based income, reducing costs, and consolidating.

Sustaining productivity growth is a particular challenge as the population ages, and new, innovative firms can play an important role. Constraints to financial access for small and medium enterprises and start-ups should be eased by further promoting risk-based lending. Alternative forms of financing for these young businesses should be further encouraged.

These long-term challenges for business models of many banks, combined with the existence of large systemic institutions, highlight the need for a strong crisis management and resolution framework.