The banking regulator Australian Prudential Regulation Authority (APRA) has finally pulled the trigger on the growing financial risks of surging house prices, forcing banks to reduce their loan amounts.
With record low interest rates continuing to inflate property prices rapidly, APRA action will require banks to test whether new customers can manage their repayments at an interest rate 3% higher than the actual rate on the loan.
That compared to a buffer of 2.5% at the moment, which means the “fairly modest” change will reduce the borrowing capacity of many borrowers by about 5%.
So, a customer who was approved for an $800,000 loan under the old rules, might face a $760,000 loan under the new rule.
Housing debt growing faster than income
APRA chairman Wayne Byres said the move is a response to housing debt growing faster than household income, which has been pushing more customers to borrow more than six times their income, which is seen as riskier lending.
“In taking action, APRA is focused on ensuring the financial system remains safe, and that banks are lending to borrowers who can afford the level of debt they are taking on – both today and into the future,” Mr Byres said.
“While the banking system is well capitalised and lending standards overall have held up, increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building.”
APRA said the change will probably have a larger effect on property investors, who usually have lower deposits and larger loans.
The ink was barely dry on the changes before property analysts said further curbs would be needed to rein in galloping prices given the current head of steam in the market.
Number of properties on the market is low
The crackdown on lending for housing comes as the number of properties available has been quite low due to the COVID-19 lockdowns – with low supply and high demand being a textbook economic recipe for rising prices.
That scenario played out beautifully in last week’s CoreLogic figures, which showed that house prices had risen more than 20% over the past year, making this the biggest annual boom since 1989.
It is an unusual boom with regional areas growing faster than cities, with prices up 1.7% in September and 23.1% over the last year, versus 1.5% and 19.5% gains for the capitals over those respective periods.
Is the boom levelling off?
There are some signs of the boom levelling off too, with the peak national monthly growth rate of 2.8% in March falling to 1.5% last month.
Adding a further wrinkle into the mix is the certainty of a federal election at some time in the near future, with no sitting government likely to be keen on reducing paper profits for millions of Australian voting home owners.
So, the question becomes how tough the ongoing crackdown on lending standards will need to be and whether it will have much effect on Melbourne and Sydney house prices, which have literally been rising by hundreds and thousands of dollars a day.
APRA changes may be just the beginning
APRA’s action follows a broad range of concerns expressed by chief executives of some of the big banks, the Organisation for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), and the Reserve Bank of Australia (RBA), which have all warned that the surge in prices could lead to financial instability.
It follows on from the regular quarterly meeting of the Council of Financial Regulators – made up of the RBA, the Australian Securities and Investments Commission (ASIC), APRA and the federal Treasury.
Treasurer joins the regulators
The latest meeting noted that house prices were rising “briskly” and may pose risks to the economy.
“The council is mindful that a period of credit growth materially outpacing growth in household income would add to the medium-term risks facing the economy, notwithstanding that lending standards remain sound,” the council stated.
Interestingly, Treasurer Josh Frydenberg attended this meeting and has also expressed concern about a possible overheating in the housing market.
Other macroprudential actions that APRA may need to look at should this change not be sufficient include imposing limits on particular types of lending – similar to the successful throttling back of interest-only loans to deter investors – or a tightening of the income-to-loan or loan-to-valuation ratios.
However, by this time increasing the interest rate servicing buffer used when calculating whether to grant a new loan, APRA may choose to continue using this measure, which is easier for the banks to build into their home loan models.
Commonwealth has already tightened its rules
Commonwealth Bank (ASX: CBA) has already moved its serviceability buffer from 5.1% to 5.25%, so it will only need to make an incremental change now.
Effectively increasing the serviceability buffer increases the ability of the bank’s customers to withstand higher interest rates before they get a loan, but also reduces the amount of money they might be able to borrow.
Both the OECD and the IMF have called on Australian regulators to step in to cool the booming Sydney and Melbourne property markets by tightening lending standards.
Loans are rising but not supply of land
The higher prices are obviously boosting the size of loans, with Australian Bureau of Statistics data showing that average new mortgages grew by $94,000 in Victoria and $120,000 in New South Wales over the past year.
While those increases may be affordable because of lower interest rates, that could quickly change and lead to a rising risk of default.
Other issues in the housing market include the very slow supply of new land developments which have worsened housing supply and affordability.
The other issue worth considering is that the emergence of the economy from the pandemic has the potential to greatly increase the number of houses for sale and potentially put some natural downward pressure on prices.
The end to lockdowns might also reverse the move towards regional property, with working from home potentially becoming less popular.