Australia's financial system is exposed to risks associated with high household indebtedness, which could “amplify and propagate an economic downturn, declines in housing prices and losses at financial institutions”, warns the RBA.
In its April Financial Stability Review, the RBA said that vulnerabilities related to household debt and the housing market in general has increased over the past six months, although noting that the nature of the risks differ across the states.
“Household indebtedness has continued to rise and in Sydney and Melbourne… in inner areas of Brisbane and some other locations, there are ongoing concerns about a future oversupply of apartments given the large volume of apartments still to be completed,” it said.
“In Western Australia and other regions exposed to the mining sector, economic conditions remain challenging and both detached house and apartment prices have fallen as income and population growth have slowed.”
The RBA pointed out that overall, household indebtedness has increased over the past six months, while income growth has remained weak.
“The aggregate household debt-to-income ratio has increased further in recent years, rising from already high levels. This has raised concerns about the household sector’s resilience to unexpected declines in income or asset prices,” it said.
“One important issue for financial stability is the number and characteristics of highly indebted households. These households are most likely to have difficulty repaying debt and sustaining consumption if their circumstances change. If the number of highly indebted households is large, their response to adverse income shocks could amplify and propagate an economic downturn, declines in housing prices and losses at financial institutions.”
Pointing to household-level information on the distribution of debt, income and wealth from the Household, Income and Labour Dynamics in Australia (HILDA) survey, the RBA underscored that the proportion of households with moderate debt-to-income ratios increased steadily between 2006 and 2014.
Most households in the ‘highly indebted’ category (those with debt-to-income ratios in the top 10 per cent of indebted households in a given survey year) had a debt-to-income ratio above 550 per cent over the 10 years to 2014, and accounted for around 35-40 per cent of total household debt.
Further, the HILDA survey showed households that were highly indebted in a particular year had a greater propensity to experience financial stress.
According to the RBA, this suggests that a greater share of highly indebted households face financial difficulties and are more likely to be vulnerable to events that affect their ability to repay their debt, such as income declines or increases in interest rates.
“Overall, these data highlight that highly indebted households can be more vulnerable to negative economic shocks and pose risks to financial stability. In particular, highly indebted households are less likely to be ahead of schedule on their mortgage repayments and they are more likely to experience financial stress, hence could be more vulnerable to adverse macroeconomic shocks,” the RBA said.
“While it is not possible to know what level of overall household indebtedness is sustainable, a highly indebted household sector is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply,” the RBA concluded.
“Rising indebtedness can make households more vulnerable to potential income declines and higher interest rates. This is of most concern for households that have very high levels of debt.”
However, the RBA noted that the HILDA data also showed that much of the debt held by highly indebted households is owed by households with high income and wealth, who are typically “better-placed” to service larger amounts of debt.