Financial stability tops banking competition: RBA

Following months of monitoring the housing and mortgage markets alongside APRA, the Reserve Bank of Australia (RBA) has released an analysis of the various macroprudential tools the regulators could initiate to rein in the housing boom.

APRA fired its first warning shot at lenders last week, raising the minimum interest rate buffer it expects banks to use to assess serviceability of home loans.

Lenders will now be required to evaluate new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3 percentage points above the loan product rate (up from the current 2.5 percentage point level).

The move will ultimately restrict maximum loan sizes for new borrowers and it could be the first of multiple steps, as APRA has not ruled against using any other measures.

In its financial stability review published on Friday (8 October), the RBA has considered the impact of potential macroprudential policies (MPP) across lenders.

As different lenders have varying risk profiles and customer bases, the RBA stated that various macro tools, including portfolio limits on riskier lending, could impact different types of borrowers – particularly if they decide to pursue riskier loans from unconstrained lenders.

“First, such rules can limit the effectiveness of MPP (and potentially even increase systemic risk) if they cause riskier borrowing to shift between lenders (including to less-regulated lenders),” the review said.

“Second, certain types of MPP can potentially entrench lending market shares and diminish competition.”

APRA had pulled the trigger on the serviceability change after expressing concerns with a rise in high debt-to-income (DTI) mortgage lending.

In the June quarter, the proportion of borrowers who attained a home loan worth six times or more of their income from the banks grew to 21 per cent.

As revealed by the RBA, loans with a DTI ratio above six times had accounted for at least 10 per cent of mortgage lending at 60 per cent of lenders during the June quarter, and at least 20 per cent of mortgage lending at 20 per cent of lenders.

Similarly, mortgages with a loan-to-value ratio (LVR) above 90 per cent accounted for at least 10 per cent of mortgage lending across 40 per cent of lenders, compared to at least 20 per cent of mortgage lending at 15 per cent of lenders.

There could be an uneven impact across lenders if the regulators imposed limits on the amount of high DTI or LVR lending banks could do, the RBA affirmed.

The RBA also noted that macro tools may have the power to hamper competition further, if they restrict borrowers’ ability to refinance existing debt.

“Measures that impose constraints at the institution level can also diminish competition in the lending market by constraining the growth of some lenders’ loan books,” the RBA review said.

“However, it is worth noting that competition and financial stability objectives can at times conflict with each other – for example, in circumstances where strong competition results in weaker lending standards.

“Under these circumstances, the benefits of supporting financial stability with MPPs could outweigh the costs to competition (particularly if these costs are temporary) but a careful assessment of this trade-off would be appropriate.”

But the Reserve Bank expressed less concern around riskier borrowers shifting across to non-bank lenders that are not prudentially regulated.

“The scope for this to increase systemic risk in Australia is limited, however, as APRA’s reserve powers would allow it to regulate the lending activities of non-bank lenders if they were to become large enough to pose material risks to the financial system,” the analysis noted.

Serviceability buffer rise won’t hurt many: RBA

The RBA has forecast a “moderate” impact from APRA’s latest action, which could take several months to realise its full impact.

It has calculated, based on current interest rates and assuming a 30-year loan term, a 50 basis point increase in the serviceability buffer will reduce maximum loan sizes for households with no other mortgage debt by around 5 per cent.

For investors who would have other existing mortgage debts, the expected effect is larger, as the increase in the serviceability rate also applies to a borrower’s existing debts.

“This is an appropriate response to target the extent and type of systemic risks that have been building,” the RBA review argued.

“The direct effect on the flow of new credit is likely to be moderate – but by ensuring borrowers have larger buffers between their income and mortgage and other expenses, it will ensure greater resilience of new borrowers, thereby reducing systemic risk.”

Further, the Reserve Bank reasoned the maximum impact of the serviceability policy could take several months to be realised.

“It may take some lenders several weeks to adjust to the new settings, and some households will have already planned or committed to purchase based on previous lending policies,” the central bank said.

“Indirect effects may take even longer than the direct effects, although changes in potential buyers’ expectations could bring forward the impact of the policy change.”

The Reserve Bank has also posited that a share of borrowers who will be constrained by the increase in the serviceability rate will only be slightly affected.

“Their desired loan size will only be a few per cent larger than their new (lower) maximum loan amount and so most will likely take out this new, slightly lower maximum loan and make other adjustments to their finances,” the review said.

“For other more constrained borrowers, including some who would have taken out their maximum loan even before the adjustment to the serviceability buffer, the reduction in the amount they can borrow will cause them to choose not to borrow at all at this time, say by delaying a property purchase.”

While survey data has suggested first home buyers are more likely than other owner-occupiers to take out a loan close to their maximum threshold, the overall share of rookie buyers the RBA has estimated will be hit by the APRA measures is “very small”.

“The overall direct reduction in the flow of new lending resulting from the change in the serviceability buffer will depend on how many potential borrowers take out a smaller loan and how many decide not to borrow at all,” the review said.

“There can also be indirect effects on new lending – less competition for properties can reduce price pressures, which in turn can lower price expectations and so curtail prospective property purchasers’ urgency to buy.”

APRA will soon release its own information paper around how it would use macroprudential tools.

[Related: Regulators should intervene sooner rather than later: Connective]