House price rise, household debt a risk to banks

In a new analysis, Moody’s Investors Service has provided an assessment of Australia’s “susceptibility to event risk”, rating it with an “a”, indicating a slightly higher risk than for some Aaa-rated peers.

The analysts said that two sources of event risk have dominated the Australian economy.

“First, rapid rises in house prices and a build-up in household debt in recent years leave the economy and financial system vulnerable to negative shocks,” analysts said.

“Our assessment of banking sector risk at ‘a’ reflects banks’ high exposure to mortgages amid elevated household leverage, and potential for a housing downturn.”

Moody’s cited data from the Bank of International Settlements, which has shown that Australia’s household debt totalled 121.4 per cent of GDP in the second quarter of 2020.

This was significantly higher than other Aaa-rated commodity-exporting sovereigns such as New Zealand (Aaa stable, 96.9 per cent), Canada (Aaa stable, 105.7 per cent) and Norway (Aaa stable, 110.0 per cent), Moody’s said.

“In addition, Australian household debt is higher than in the US (Aaa stable), Ireland (A2 stable) and Spain (Baa1 stable) in 2007 around their pre-crisis housing peaks,” analysts said.

Furthermore, Australia’s ratio of household debt to disposable income has also remained at significantly high levels, at 179.9 per cent as of September 2020, they added.

However, the credit ratings agency said that there are factors that could mitigate the potential sovereign credit impact of this risk, which it said was consistent with its overall “a” assessment of susceptibility to event risk.

“Should house prices fall significantly, beyond recent relatively moderate declines, the strong capitalisation of Australian banks and their generally high intrinsic financial strength significantly reduce the risk of a banking crisis and any eventual cost for the sovereign,” it said.

However, recent property price forecasts have pointed to double-digit increases in prices over the near term amid record-low interest rates and strong lending figures, with the Commonwealth Bank of Australia (CBA) predicting a 16 per cent rise in house prices over the next two years, and a 14 per cent rise in overall property prices.  

A Freedom of Information document released by the Reserve Bank of Australia (RBA) had recently revealed that a permanent, 100-basis-point reduction in the cash rate would push real house prices up by 30 per cent after about three years, while a temporary reduction would increase house prices by 10 per cent.

Overall, Moody’s stated that the credit profile of Australia (Aaa stable) is supported by very high economic strength, evident in consistently strong and stable growth despite the challenges posed by the coronavirus pandemic.

“A very robust institutional framework underpins the credit, and offsets potential economic and financial stability risks,” it said.

“Challenges stem from high household debt and a large external liability position.”

[Related: Mortgage demand up 19.3% in December quarter]