Tag: Macroprudential

The Future Shape of Banking Regulation

In a speech entitled “The fence and the pendulum“, by Martin Taylor, External Member of the Financial Policy Committee, Bank of England, he discusses the thorny problems of macroprudential policymaking, which very much include the bank capital and too-big-to-fail agenda. It is worth reading in full.

He concludes:

This is a crucial time for the new international order in bank regulation. We are close to agreement on new standards that the industry, in the UK at least, is not too far off meeting. Four years ago that would have seemed a highly desirable outcome but quite an unlikely one. It’s good for our economies, and it will turn out to be good for the financial industry over the next quarter-century. At the same time the emergence – well, they never went away – the increasingly shrill emergence of voices calling for a regulatory softening is both structurally wrong and conjuncturally wrong. It remains the ungrateful job of the supervisors to save the banks from themselves. The shortness of human memory span and the speed with which we forget the ghastly misjudgements of the recent past: these are the enemies, the unresting enemies, alas, of financial stability.

Cold Hand Of The Regulator On Bank’s Investment Lending

Following the disclosures in the recent bank results that many were above the APRA target of 10% portfolio growth, and their statements they would work to fall within the guideline, we have seen a litany of changes from the banks, which marks an important change in tempo for investment home lending. Regulatory pressure is beginning to strangle investment lending growth.  Better late then never.

In the past few days, ANZ has stated it would no longer offer interest rate discounts to new property investor borrowers who did not also have an owner-occupied home loan with the bank; Westpac is cutting discounts to new investment property borrowers according to the AFR; and Bankwest has imposed a loan-to-valuation ratio cap of 80 per cent on investor Mortgages. Changes that took effect on Friday will mean Macquarie customers taking out fixed-rate investor or interest-only loans will pay higher rates than owner occupied borrowers. Recently the Commonwealth Bank, scrapped its $1,000 investment home-loan rebate offer and reduced pricing discounts for investment home loans. In addition more broadly, Bank Of Queensland has changed its underwriting practices. NAB has also changed its instructions brokers, and as of May 13, NAB would only consider pricing below advertised rates for owner-occupiers or personal loans. “Investment loans will not be eligible for any pricing discretions. Advertised rates will apply to investment loans,” the note said. Suncorp plans to pare down discounts for investor property loans while boosting incentives for homeowner lending, in reaction to the regulatory crackdown on housing markets.

Last week we showed that currently discounts are at their peak, so will we see overall discounts cut, or reinvigorated discounts on selected owner-occupied lending? Banks need home loan lending growth to make their business work. We think the focus will be on a drive to accelerate refinancing of existing loans, so expect to see some amazing offers in coming weeks to try and fill the gap.

We know from our surveys there is still significant demand for housing finance out there. We also know that some of the non-ADI players are playing an increasing role in the investment lending sector, and these players are of course not regulated by APRA. Securitisation of Australian home loans was up last quarter, and most were purchased by Australian investors.

Mortgage brokers, who have been enjoying the recent growth ride may suddenly be finding their world just changed.

Whilst its a change in tempo, its not necessarily the end of the mortgage lending boom. It may however be the tipping point on house prices in Sydney and Melbourne, where investment loans have been responsible for much of the rise.

 

 

Domestic and Cross-border Spillovers of Unconventional Monetary Policies

Interesting remarks from Benoît Coeuré, Member of the Executive Board of the European Central Bank, at the SNB-IMF Conference “Monetary Policy Challenges in a Changing World”, Zurich today. The discussion centres of the risk of bubbles when interest rates are artificially low, and exacerbated by other unconventional monetary strategies, why investment property is attractive in these conditions, and how macroprudential should be used to manage these unintended consequences in the context of growth. An edited version follows:

In recent years, there has been an intense discussion, both at the national and the international level, about the  potential financial market implications of unconventional monetary policies. At the international level, policy makers have been particularly concerned with the surge in capital inflows, and the resulting exchange rate appreciation pressures in emerging markets. More recently, amid monetary policy normalisation in the United States and additional monetary policy easing in the euro area, including through the launch of the public sector purchase programme (PSPP), a new, but conceptually related discussion has emerged on the global financial market implications of diverging monetary policy cycles. At the national level, the main concerns were spillovers to equity and real estate markets, and the worries about the emergence of asset price bubbles as a result of unconventional policy measures.

Monetary policy always has unintended consequences, no matter where it is pursued. By altering short-term interest rates, central banks affect the inter-temporal decisions of households. Inter-temporal redistribution is at the heart of monetary policy that is aimed at ensuring price stability, and it thus has effects on the income distribution of savers and spenders.

But monetary policy also affects the distribution of income along the intra-temporal and spatial (cross-country) dimension. Changes in short-term interest rates affect consumption, savings and wealth in different ways, depending on the characteristics of individual households in different jurisdictions. But all these effects can be considered temporary, indirect and unintended, i.e. a side effect of a strategy that is aimed at ensuring price stability in the economy.

That said, it would be a logical fallacy to conclude that all domestic spillovers are acceptable. Bubbles are a case in point. Bubbles are a possible, but not an inevitable result of unconventional monetary policies. And if they are welcome at all, then only in a severely constrained, second-best world. But in this case, we should ask ourselves how we can overcome the constraints that prevent better policy outcomes, rather than settling for bubbles to temporarily mask the constraints.

Facing the threat of a persistent low-growth and low-inflation environment and a binding floor on standard policy rates, many central banks have resorted to unconventional measures. These measures were aimed at further pushing down nominal interest rates along the maturity spectrum to track the secular decrease in the natural, “Wicksellian” real rate of interest. Thereby, they helped induce firms and households bring forward their investment and consumption spending in comparison with that in a no policy-change scenario and, ultimately, bring the natural rate back to more normal levels.

I am convinced that there is no alternative for us than acting this way in order to deliver on our mandate. Yet, there is a danger associated with the temporary, yet potentially extended period where low interest rates are needed to stimulate investment and consumption. With real interest rates below potential growth, private agents may just borrow to purchase assets in limited or rigid supply (e.g. real estate property). In this dynamically inefficient world with structurally weak growth prospects, this may actually become an attractive way for savers to generate returns on their savings that investments in the productive sector are unable to generate.

In this case, we end up with a “rational bubble”. While unconventional monetary policy is not a necessary condition for this type of bubble to emerge, it may render it more likely – and more violent in the event of its materialising. So what are the consequences of such bubble?

In the short-term, it may indeed generate a temporary boost to the economy. And for a while this boost would be difficult to distinguish from the regular workings of asset purchase programmes, which actually embed asset price increases as a desired effect, which passes on the initial impulse to broader financing conditions via portfolio rebalancing. But this boost would ultimately be very costly. Not only does it does it come with welfare decreasing macroeconomic instability, but it also brings about an arbitrary redistribution of wealth that may, in the worst case, undermine social cohesion and trust that the central bank is acting within its narrow price stability mandate. And moreover, it can create financial stability risks elsewhere, generating negative spillovers from what should otherwise be a normal international adjustment process.

Against this background, it would be wrong to treat bubbles as a welcome replacement therapy to a sustainable growth model. Instead,  macroeconomic and structural policies have to set the necessary conditions so that investment in productive sectors becomes attractive again and investment in bubble-prone areas is discouraged, so that total factor productivity is increased and the natural rate of interest ultimately reverts to what is normal.

We take monetary policy decisions with a view to attaining our primary objective of price stability. Thereby, we establish a stable nominal anchor for the private sector, which in turn is a fundamental precondition for overall macroeconomic stability. Without prejudice to this objective, we take financial stability risk seriously and monitor closely whether severe imbalances are emerging in the financial sector. In this context, we consider the financial stability risks related to our policy measures to be contained. Should risks emerge, macro-prudential policy is best suited to safeguard financial stability. Macroprudential instruments can be targeted more efficiently to those sectors and countries where systemic risks may be materialising. Finally, we encourage national authorities to do whatever is in their power to place the euro area on a more dynamic growth path, thereby creating attractive investment projects that generate high, but fundamentally justified, returns. These are the conditions for unconventional monetary policies policies to bring economies back to a stable and sustainable growth path, both at home and abroad.

RBNZ Announces New LVR Restrictions on Auckland Housing

New Zealand’s financial system is sound and operating effectively, but faces significant risks, Reserve Bank Governor, Graeme Wheeler, said today when releasing the Bank’s May Financial Stability Report.

Mr Wheeler identified three systemic risks facing the New Zealand financial system.

“Auckland’s median house price is 60 percent above its 2008 level, and house prices in Auckland have been rising rapidly since late last year. This reflects ongoing supply constraints and increased demand, driven by record net immigration, low interest rates and increasing investor activity. Prices in the Auckland region have become very stretched, increasing the risk of financial instability from a sharp correction in prices.

“A second area of risk for the financial system relates to the dairy sector, which is experiencing a sharp fall in incomes due to lower international prices. Many highly leveraged farms are facing negative cash-flows, and the risks will become more pronounced if low milk prices persist beyond the current season.

“The third key risk arises from the current very easy global financial conditions. Low interest rates are encouraging investors into riskier assets in the search for yield. Prices of both financial and real assets are becoming overextended in many markets. There is an increasing risk that the current benign conditions unwind in a disorderly fashion, disrupting the cost and availability of funding for the New Zealand financial system.”

LVR Restrictions

In response to the growing housing market risk in Auckland, the Reserve Bank is today announcing proposed changes to the loan-to-value ratio (LVR) policy. The policy changes, proposed to take effect from 1 October, will:

• Require residential property investors in the Auckland Council area using bank loans to have a deposit of at least 30 percent.

• Increase the existing speed limit for high LVR borrowing outside of Auckland from 10 to 15 percent, to reflect the more subdued housing market conditions outside of Auckland.

• Retain the existing 10 percent speed limit for loans to owner-occupiers in Auckland at LVRs of greater than 80 percent.

“We are proposing these adjustments to the LVR policy to more directly target investor activity in the Auckland region, where house prices relative to incomes and rent are far more elevated than elsewhere in New Zealand.

“The objective of this policy is to promote financial stability by reducing the rate of increase in Auckland house prices, and to improve the resilience of the banking system to a potential downturn in the Auckland housing market.”

Mr Wheeler emphasised that while the new measures aim to moderate housing demand, policies to ease housing supply constraints in Auckland remain the key to addressing the region’s housing imbalances over the longer term.

Deputy Governor, Grant Spencer, said that the Bank will issue a consultation paper in late May, providing further details and seeking feedback on the new LVR proposals.

“Prior to the proposed introduction of the policy in October, we expect banks to observe the spirit of the restrictions and not seek to expand high-LVR investor lending in Auckland.

“Given the importance of encouraging residential construction activity in Auckland, and consistent with the existing LVR policy, the proposed LVR restrictions will not apply to loans to construct new houses or apartments.

“Consistent with the LVR measures, the Reserve Bank is establishing a new asset class for bank loans to residential property investors. Banks will be expected to hold more capital against this asset class to reflect the higher risks inherent in such lending.

“Following a lengthy consultation process, we have decided that a residential property investor loan will be defined as any retail mortgage secured on a residential property that is not owner-occupied.”

A summary of submissions received in response to the consultation will be released later this month, and details will be provided on the implementation of the new asset class, including on the proposed capital treatment of residential investor loans.

The new asset class will take effect from 1 October 2015 for new lending, with a further phase-in period of nine months for the reclassification of existing loans.

“Given the broader risks facing the financial system, it is crucial that banks maintain their capital and liquidity buffers and apply prudent lending standards. Later this year the Reserve Bank will be reviewing bank capital requirements in light of global and domestic developments affecting the safety of the banking system,” Mr Spencer said.

RBA Rate Cut Increases Need for Greater Macro-Prudential Response – Fitch

Fitch Ratings says the Reserve Bank of Australia’s (RBA) recent interest rate cut is likely to lead to a strengthened macro-prudential response from the Australian Prudential Regulatory Authority (APRA) for the Australian banking system, although implementation will probably remain targeted and occur on a bank-by-bank basis.

Today’s rate cut is likely to further fuel the Australian property market, particularly in Sydney, at a time when the authorities are trying to take the steam out of the market. Macro-prudential tools allow the regulator to influence banks’ risk appetite, preserving asset quality and limiting potential losses in the event of an economic shock. The Australian banking system benefits from strong loss absorption capacity given the banks’ sound profit generation and provision levels, as well as adequate capitalisation. These strengths could be undermined by further increases in property prices and household debt, given mortgages form the largest asset class for Australian banks.

APRA has targeted certain higher risk areas such as investor mortgages, indicating growth in excess of 10% per annum would trigger closer regulatory monitoring and may lead to tougher capital requirements. In addition, APRA could use a set of other macro-prudential tools which may include a combination of debt-servicing requirements, additional capital requirements and/or loan-to-value ratio (LVR) restrictions, depending on each lender. Given the existence of lenders’ mortgage insurance (LMI), which mitigates the banks’ risk of higher LVR mortgages, debt-servicing requirements and higher capital requirements on a bank-by-bank basis are likely to be the preferred options.

Growing risks in the housing market and the banks’ mortgage portfolios could be exacerbated if further macro-prudential scrutiny is not forthcoming. The recent interest rate cut may lead to further house price appreciation, especially in cities such as Sydney and Melbourne, where there has been greater investor activity over the past 12 to 18 months. The first rate cut in February 2015 was followed by increased activity in these housing markets. The growth in house prices exceeded lending growth up to the end of 2014, but this trend could reverse as interest rates are at historical lows. At the same time, it makes borrowers vulnerable to a potential increase in interest rates in the medium term. Australia has one of the highest household debt levels globally, and if low interest rates contribute to higher credit growth, it could drive up household indebtedness from already historically high levels.

Falling interest rates may also result in further growth in potentially higher-risk loan types, such as interest-only and investor loans. These loan types already represent a high proportion of new approvals for Australian banks, as shown in Fitch’s “APAC Banks: Chart of the Month, February 2015”. The proportion of new interest-only mortgages is higher than new investor mortgages, suggesting that owner-occupiers are increasing the use of these types of loans at a time when historically-low interest rates should encourage borrowers to pay off debt. Serviceability testing at Fitch-rated Australian banks may provide some offset to this risk, with loans assessed on a principle and interest basis and at interest rates well above the prevailing market rate.

 

When Is Macroprudential Policy Effective?

Given the buoyant housing market, and the potential risks which are exposed, there has been significant interest in the potential use of macroprudential tools to try and help alleviate the worst excesses. But some question whether they are, in fact, effective. A recent Bank For International Settlements Working paper casts some interesting light on this question. BIS Working Papers No 496 When is macroprudential policy effective? by Chris McDonald of the Monetary and Economic Department was released in late March.

Loan-to-value (LTV) and debt-to-income (DTI) limits have become increasingly popular tools for responding to house price volatility since the global financial crisis. Nonetheless, our understanding of the effects of these policies is uncertain. One aspect not well understood is how their effectiveness varies over the cycle. It is also not clear if the effects of tightening and loosening are symmetric. This paper seeks to address these issues by considering the effects of policy changes at different parts of the housing cycle. Then, controlling for this, I evaluate if the effects of tightening and loosening are symmetric or not.

There are at least two inter-related reasons for using macroprudential policies: (i) to create a buffer (or safety net) so that banks do not suffer overly heavy losses during downturns; and (ii) to restrict the build-up of financial imbalances and thereby reduce the risk of a large correction in house prices. Here I examine the relationship between changes in LTV and DTI limits and the build-up of financial imbalances. There is a growing group of economies that use macroprudential policies to target imbalances in their housing markets in this way. This analysis relies on the experience of these economies: many of which are from Asia, though the results are likely to be relevant to other economies as well.

The literature on the effectiveness of macroprudential policies at taming real estate cycles has grown quickly since the 2008 financial crisis. For a wider discussion on the effectiveness of macroprudential policies, the background papers by the Committee on the Global Financial System (2012) and the International Monetary Fund (2013) provide a good overview. The consensus is that these measures can contain housing credit growth and house price acceleration during the upswing. Kuttner and Shim (2013) estimate the effects of a range of policy changes on housing credit growth and house price inflation across 57 economies. They find that tightening DTI limits reduces housing credit by 4 to 7 percent, while tightening LTV limits reduces housing credit by around 1 percent. Crowe et al (2011) also find evidence that LTV limits prevent the build-up of financial imbalances. They find that the maximum allowable LTV ratio between 2000 and 2007 was positively correlated with the rise in house prices across 21 economies.

By looking at 100 policy adjustments across 17 economies, I find that changes to LTV and DTI limits tend to have bigger effects when credit is expanding quickly andwhen house prices are relatively expensive. Tightening measures (such as lowering the maximum LTV ratio) during upturns lower the level of housing credit over the following year by 4-8 percent and the level of house prices by 6-12 percent.

Conversely, during downturns they reduce housing credit by 2-3 percent and house prices by 2-4 percent. This is consistent with the finding of Classeans et al (2013): that the persistent (or long-run) effects of LTV and DTI limits increase with the intensity of the cycle. Several measures of the housing cycle correlate with the effects of changes to LTV and DTI limits. Stronger credit growth before tightening is associated with bigger effects. While there might be several reasons for this, one explanation is that lending is available to more marginal borrowers during booms. High house-priceto-income ratios are also correlated with bigger tightening effects. Limits on LTV and DTI ratios appear to become more constraining when houses are expensive. This may be an important element for explaining cross-country differences in the effectiveness of macroprudential policies, given that house-price-to-income ratios can differ substantially.

Tightening LTV and DTI limits appears to be more effective than loosening them, as found in past research. In downturns, ie when credit growth is weak and house prices are relatively cheap, tightening reduces the level of housing credit by around 2-3 percent and loosening raises it by 0-3 percent. Given the bounds of uncertainty, these are not that different – consistent with loosening having small effects because it usually occurs during downturns.

How Does Macroprudential Impact Foreign Banks?

The Bank of England just released a paper which examines whether cross-border spillovers of macroprudential regulation depend on the organisational structure of banks’ foreign affiliates. On a tight leash: does bank organisational structure matter for macroprudential spillovers?  Piotr Danisewicz, Dennis Reinhardt and Rhiannon Sowerbutts.

Do multinational banks’ branches reduce their lending in foreign markets more than subsidiaries in response to changes in the regulatory environment in their domestic markets? And if so, how strong is this effect and how long does it last?

Studies show that multinational banks transmit negative shocks to their parent banks’ balance sheets – including changes in regulation – across national borders. In this paper we examine if the magnitude of the spillover effects depends on the organisation structure of banks’ foreign affiliates. We exploit cross-country cross-time variation in the implementation of macroprudential regulation to test if lending in the UK of foreign banks’ branches and subsidiaries respond differently to a tightening of capital requirements, lending standards or reserve requirements in foreign banks’ home countries.

Focusing on differences in lending responses of branches and subsidiaries which belong to the banking group allows us to control for all factors which might affect parent banks’ decisions regarding their foreign affiliates’ lending. Our results show that whether foreign branches or subsidiaries react differently to changes in regulation in their home countries depends on the type of regulation and the type of lending.

Multinational banks’ branches respond to tighter capital requirements in their home countries by contracting their lending more than subsidiaries. On average, branch interbank lending growth in the UK grows by 6.3 percentage point slower relative to subsidiaries following a tightening of capital requirements in the bank’s home country. This is in line with our hypothesis which predicts that branch lending will be affected due to higher degree of control which parent banks have over its foreign branches. But this heterogeneity in response to capital requirements is only observed in case of lending to other banks. We find that the response of lending to non-bank borrowers to a tightening in capital requirements does not depend on the organisational forms of foreign banks’ UK affiliates. Turning to the impact of a tightening in lending standards or reserve requirements, we find that there are no differential effects on interbank and non-bank lending.

Additional analysis suggests that the stronger contraction in the provision of interbank loans exhibited by branches is only contemporaneous – ie the differential effect fades out after one quarter. Our research provides some evidence that a branch structure is more likely than a subsidiary structure to transmit a tightening in capital requirements affecting the parent institution in the home country. However, the effects we find are short-lived which means that the potential negative effects associated with a higher number of foreign branches we find in this study may not necessarily outweigh any benefits.

UK Macroprudential Update

The Bank of England just released their latest Financial Stability report. Within the document there is a section on the implementation of macroprudential measures relating to mortgage lending. This makes an interesting contrast with the Australian Regulatory framework.

Mortgage affordability test – Implemented: When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage
points higher than the prevailing rate at origination.

Loan to income limit – Implemented: The PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income ratios at or greater than 4.5. This Recommendation applies to all lenders which
extend residential mortgage lending in excess of £100 million per annum.

Powers of Direction over leverage ratio – Action under way: The FPC recommends that HM Treasury exercise its statutory power to enable the FPC to direct, if necessary to protect and enhance financial stability, the PRA to set leverage ratio requirements and buffers for PRA-regulated banks, building societies and investment firms, including:

  1. a minimum leverage ratio requirement to remove or reduce systemic risks attributable to unsustainable leverage in the financial system;
  2. a supplementary leverage ratio buffer that will apply to G-SIBs and other major domestic UK banks and building societies, including ring-fenced banks to remove or reduce systemic risks attributable to the distribution of risk within the financial sector;
  3. a countercyclical leverage ratio buffer to remove or reduce systemic risks attributable to credit booms — periods of unsustainable credit growth in the economy.

The Government intends to lay the final legislation before Parliament in early 2015, alongside publishing a consultation response document and impact assessment. As with the housing instruments, the FPC intends to issue a draft Policy Statement in early 2015 to inform the Parliamentary debate.

HM Treasury intends to consult separately on LTV/interest coverage ratio powers for the buy-to-let sector in 2015, with a view to building further evidence on how the UK buy-to-let housing market may pose risks to financial stability.

Housing Finance Regulation – Tweaked, Not Reformed

Fresh on the heels of the FSI report, the core thesis of which is that the Australian Banks are too big to fail, so capital buffers must be increased to protect Australia from potential risks in a down turn (a “mild” crash could lead to the loss of 900,000 jobs and a $1-2 trillion or more cost to the economy), it was interesting to see the publication yesterday by APRA of the guidelines for mortgage lending, and ASIC’s targetting interest only loans. This action is coordinated via the Council of Financial Regulators (CFR). This body is the conductor of the regulatory orchestra, and has only had an independant website since 2013.  It is the coordinating body for Australia’s main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The Reserve Bank of Australia (RBA) chairs the Council and members include the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and The Treasury. The CFR meets in person quarterly or more often if circumstances require it. The meetings are chaired by the RBA Governor, with secretariat support provided by the RBA. In the CFR, members share information, discuss regulatory issues and, if the need arises, coordinate responses to potential threats to financial stability. The CFR also advises Government on the adequacy of Australia’s financial regulatory arrangements.

Whilst FSI recommended beefing up ASIC, and introducing a formal regulatory review body, it did not fundamentally disrupt the current arrangements. Interestingly, CFR is a direct interface between the “independent” RBA and Government.

So, lets consider the announcements yesterday. None of the measures are pure macroprudential, but APRA is reinforcing lending standards by introducing potential supervisory triggers (which if breached may lead to more capital requirements, or other steps) using an affordability floor of 7% or more (meaning if product interest rates fell further, banks could not assume a fall in serviceability requirements) and at least an assumed rise in rates of 2% from current loan product rates. In addition, any lender growing their investment lending book by more than 10% p.a. will be subject to additional focus (though APRA makes the point this is not a hard limit). These guidelines relate to new business, and does not directly impact loans already on book (though refinancing is an interesting question, will existing borrowers who refinance be subject to new lending assessment criteria?) ASIC is focussing on interest-only loans, which are growing fast, and are often related to investment lending.

The banks currently have different policies with regards to serviceability buffers. Analysts are looking at Westpac in the light of these announcements, because it grew its investment housing lending book fast, uses 180 basis points serviceability buffer and an interest rate floor of 6.8%. Investment property loans make up ~45% of WBC’s housing loan portfolio (compared with the majors average of ~36%), and has grown at ~12% year on year this financial year (compared with the average across the majors of ~10%). WBC made some interesting comments in their recent investor presentation relating to investment loans, highlighting that investors tended to have higher incomes than owner occupied loans.

WBCInvestorDec2014Other banks have different underwriting formulations with buffers of between 1.5% and 2.25% buffers. ASIC has of course also stressed that lenders must consider borrowers ability to repay and take account other expenditure. There is evidence of the “quiet word from the regulator” working as recently we have noted some slowing investment lending at WBC (currently they would be below the 10% threshold) and amongst some other lenders too. However, some of the smaller lenders may be impacted by APRA guidance, given stronger recent growth.

What does this all mean. First, we see now what APRA meant in their earlier remarks “collecting additional information, counselling the more aggressive lenders, and seeking assurances from Boards of our lenders that they are actively monitoring lending standards. We’re about to finalise guidance on what we see as sound mortgage lending practice”. Second, we do not think this will materially slow down housing investment lending, and this is probably what the RBA wants, given its belief consumer spending should replace mining investment as a source of growth.  The regulators are trying to manage potential risks in the system, by targetting higher risk lending whilst letting housing lending continue to run. Third, it leaves open the door to macroprudential later if needed. Lastly, existing borrowers may be loathe to churn if they are now required to meet additional buffers. This may slow refinancing, and increase longevity of loans in portfolio (and loans held longer are more profitable for the banks).

 

OECD Warns Again On Housing

The OECD Economic Outlook 2014 Issue 2 has been released in a preliminary version. There are some important warnings which the RBA should heed. Essentially, OECD is highlighting again the risks in the current RBA policy of using low interest rates to drive housing growth in lieu of mining investment. They appear to believe rates should be taken higher and additional prudential measures should be taken.

Output growth is projected to dip to 2.5% in 2015 but recover to 3% in 2016. Declining business investment will be countered by gathering momentum in consumption and exports. Growth at the projected pace will be enough to lower the unemployment rate, although consumer price inflation will remain moderate due to economic slack.

Fiscal policy should continue to aim for a budget surplus by the early 2020s but given economic uncertainties, it should avoid heavy front loading. Short of negative surprises, withdrawal of monetary stimulus should start in the second quarter of 2015. The booming housing market and mortgage lending will require close attention by the authorities. There is room for both fiscal and monetary policy to provide  support in the event of unexpected negative economic shocks.

The Australian economy is going through a period of adjustment as activity has to shift from the previously booming resource sector. Cooling commodity prices and declining resource-sector investment have resulted in job and output losses, but a lower exchange rate is lifting employment and exports elsewhere in the economy. House price increases are encouraging construction and consumption, but are also a concern in that a sharp reversal could cut aggregate domestic demand.

The Reserve Bank of Australia’s (RBA’s) policy rate has remained at 2.5% since August 2013, well below historical norms. Though helping economic adjustment, this monetary support has intensified search for returns by investors. This requires close oversight of asset-market developments, particularly rising housing credit, which is now being driven by investors. Further prudential measures on mortgage lending should be considered as a targetted means to cool the market, thereby heading off risks to financial stability.

OECDNov2014

External risks remain prominent, with recent steep falls in some commodity prices exemplifying the potential for rapit change in resource revenues. Domestically, the momentum in property prices is uncertain and could unwind sharply. When and how quickly non-0mining investment picks up is uncertain, as is the degree to which households will dip further into savings to sustain their consumption.