RBA Urges Banks Hold Loan Standards as Risk Appetite Grows

The Reserve Bank of Australia urged the nation’s lenders to maintain loan standards as record-low interest rates spur households’ investment appetite.

“There are some signs that households are taking on more risk in their investment decisions,” the RBA said in its semiannual financial stability review released in Sydney today. It is important that banks “do not respond to pressures to boost revenue by imprudently loosening their lending standards, or by making ill-considered moves into new markets or products.”

The RBA has lowered borrowing costs by 2.25 percentage points in an almost two-year easing cycle to a record low of 2.5 percent, to help offset the drag on the economy from a high currency and boost industries including construction as mining investment wanes. The rate reductions have fueled the property market, with prices in Sydney, the nation’s biggest city, jumping 8.3 percent so far this year.

“It is important that those purchasing property do so with realistic expectations of future dwelling price growth,” the central bank said. “The potential for a further increase in property gearing in self-managed superannuation funds, SMSFs, is a development that will be monitored closely by authorities for its implications both for risks to financial stability and consumer protection.”

Pension Funds

Australian employers must contribute 9.25 percent of workers’ salaries to an authorized pension fund, driving growth of the country’s retirement savings system to A$1.6 trillion ($1.5 trillion). Savers, some dissatisfied with the fees charged by professional managers for the returns they deliver, have pumped A$506 billion into Self-Managed Superannuation Funds, or SMSFs, the largest piece of the pension pie.

“SMSFs allocate a relatively large share of their assets, 15 percent, to direct property holdings, both commercial and residential,” the central bank said. “One risk of the increase in property investment by SMSFs is that at least some of it is a new source of demand that could potentially exacerbate property price cycles.”

Australia’s household debt-to-income ratio stands at 147.3 percent, compared with a record 153 percent in 2007, RBA data show. That’s higher than the 133 percent Americans accumulated at the peak of the U.S. subprime mortgage boom, according to the Federal Reserve Bank of San Francisco.

Housing across Australia’s major cities could rise as much as 11 percent on average in 2014, according to SQM Research Pty, which assumes no more than one 25 basis-point rate cut. All of Australia’s major cities will see increases, except Canberra, which is expected to record declines of as much as 4 percent, the Sydney-based property researcher said in its Housing Boom and Bust Report.

Bank Earnings

Commonwealth Bank of Australia, Westpac Banking Corp., Australia & New Zealand Banking Group Ltd. and National Australia Bank Ltd. -- named the so-called four pillar lenders for a law that prevents them from buying each other -- reported A$13 billion combined profit for their latest six-month results, about 10 percent higher than the previous half, the RBA said. Revenue growth of 4 percent was slightly lower than in recent years, reflecting slower growth in net interest income.

“The relatively modest rate of growth in credit, and hence bank balance sheets, poses a strategic challenge for Australian banks,” the RBA said.

Banks’ cost-to-income ratio, at 40 to 45 percent, is at the bottom end of the range of their global peers after they reduced staff and moved some functions offshore. “While there is little sign at this stage that the banks’ cost containment has strained their risk management capabilities or controls, there is a question as to how much further they can improve this measure of efficiency without doing so.”

N.Z. Restrictions

The RBA said that Australian banks’ loan performance has continued to improve in New Zealand, as rural and housing market conditions have continued to strengthen there. It noted the Reserve Bank of New Zealand’s decision to modestly increase capital requirements on residential mortgages and restrict banks’ new mortgage lending at higher loan-to-valuation ratios.

“However, actions to circumvent the RBNZ’s lending restrictions or to relax lending standards for other borrowers could pose problems once interest rates eventually rise, or in the event of a downturn in economic and property market conditions there,” the RBA said.

Risk Taking

In Australia, the central bank said that the risk profile of new household borrowing remains reasonably sound. It said anecdotal evidence suggests that around half of households have not reduced their regular mortgage payments as rates fell.

Mortgage buffers remain near their highs at 14 percent to outstanding mortgage balances, it said. That is equivalent to around 21 months of total scheduled repayments at current interest rates, it said.

Australian households retain firepower for higher spending: the savings rate has held above 10 percent of disposable income in the 15 months through June, compared with a low of minus 0.1 percent in the first quarter of 2006.

“Survey data suggest that over the past year or so, the share of households that believe that paying down debt is the ‘wisest’ use of their savings has decreased,” the central bank said. “While increased financial risk-taking is an expected outcome of lower interest rates, it is important that households understand, and appropriately account for, the financial risks they take.”

For business, while conditions are a little below average and failure rates are higher than average, potential risks are likely to be “mitigated by the low level of gearing and limited appetite for taking on debt,” the central bank said.

“In the period ahead, market expectations are for profitability to pick up, while the depreciation of the Australian dollar since the beginning of the year should provide support to some trade-exposed sectors,” it said.

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