High mortgage exposure pushes up banking risk

International ratings agency Moody’s has downgraded Australia’s banking sector risk from “an indicative very low” to “very low” to reflect the banks’ “high exposure to mortgages amid increasing housing leverage, and potential for a housing downturn”.

While the agency reaffirmed Australia’s AAA credit rating due to the country’s economic resilience in an "uncertain global environment", the country's "robust" institutional framework and Australia's strong fiscal metrics as compared with global peers — it said that the banking sector remains more susceptible to “event risks” than other, similar countries.

According to the agency, “rapid rises in house price and a build-up in household debt in recent years leave the economy and financial system vulnerable to negative shocks”.

Moody’s pointed to figures from the Bank for International Settlements, which states that Australia’s household debt amounted to 123 per cent of GDP in the second quarter of 2016, much higher than other AAA-rated commodity export sovereigns such as New Zealand (94 per cent), Canada (99.8 per cent) and Norway (98.9 per cent).

Household debt is also currently higher than in the US, Ireland and Spain in 2007 prior to their respective pre-GFC house price peaks, said the agency. Moody’s says that low interest rates — which have sat at a record low of 1.5 per cent since August — have “likely facilitated” the rise in household debt in Australia.

A note from Moody’s Investors Service said: “Household debt rose to a fresh record high of 187 per cent of annual gross disposable incomes in the September quarter, continuing an upward trend that has resulted in a 20 percentage point increase in the ratio since March 2013. This leaves the economy and financial system vulnerable to negative economic or interest rate shocks that could precipitate a correction in the housing market.

“Still, ample capital buffers, a point highlighted in a recent speech by RBA governor Philip Lowe, point to strong resilience of the banking system to shocks.

“Moreover, households have balances in mortgage offset and redraw facility accounts equivalent to 17 per cent of total outstanding housing loans, which is a buffer worth 2.5 years of scheduled repayments at current interest rates.

“These factors mitigate the probability and potential costs of government support to the banking system should house prices fall abruptly.”

Touching on inflation — which recent figures from the Australian Bureau of Statistics show is at a 20-year low — Moody’s said that despite inflation remaining “subdued” at an average 1.5 per cent year-on-year, it expects it to “pick up” to 2 per cent in 2017, and rise “slightly higher” than that in 2018, thus “remaining within the central bank’s 2 per cent to 3 per cent inflation target”.

[Related: Major bank makes dramatic change to housing outlook]

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Annie Kane

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