Debt control: too little, too late?

It’s pretty clear from RBA governor Philip Lowe’s speech on Thursday that the central bank expects rates to rise in the not-too-distant future. Australia has typically looked to the global economy for its cues on monetary policy. Last week, US Federal Reserve chair Janet Yellen suggested that rates could be on the rise.

Meanwhile, the latest rhetoric coming out of the Reserve Bank, from both Mr Lowe and assistant governor Luci Ellis, is heavy on the pick-up in the global economy and this transition away from loose monetary policy as a growth catalyst. However, it's worth noting Lowe's comment that "a rise in global rates has no automatic implications for Australian rates." Some things take time. 

If Australia starts to look as if it can stand on its own two feet without the support of a record-low cash rate, then that is a great outcome for some. Savers, for example, and investors on the yield pilgrimage.

But it creates serious implications for households leveraged to the hilt.

“Higher levels of debt also mean that household spending could be quite sensitive to increases in interest rates, something the Reserve Bank will be paying close attention to,” Mr Lowe said on Friday (22 September).

“Our concern has been that, in this environment, a small shock could turn into a more serious correction as households seek to repair their balance sheets.

“We have been working with APRA through the Council of Financial Regulators to address this risk. The various measures are having a positive impact in improving the resilience of household balance sheets.”

The CFR is basically the regulatory trifecta of APRA, ASIC and the RBA. Treasury is also a member. Each has very different remits, but combined, they are responsible for promoting stability in the Australian financial system.

Macro-prudential measures, commonly known as lending curbs and courtesy of APRA, taken with ASIC’s increased oversight on lending standards, fit together with the Reserve Bank’s job of setting monetary policy.

The CFR’s work to stabilise the financial system has been primarily concerned with mortgage lending.

Interestingly, RBA assistant governor Luci Ellis commented last week that while strong lending standards mitigate the effects of moderate shocks, and can help prevent a shock turning into a default event, "in the face of a large, economy-wide shock, even the best lending standards might not be enough to protect borrowers and lenders”.

Risk already in the system

Regulators will tell us that curbing investor and interest-only lending is a preventative measure. Senior executives at a number of Australian banks disagree. One told this reporter that there is far more risk in the system than people think.

Mortgage brokers are at the coal face of a tighter credit environment. It is not uncommon for a broker to run a client’s numbers through the calculator and realise that they would simply be unable to secure the same level of debt they hold today if they were to apply for it in the current climate.

Digital Finance Analytics principal Martin North believes that the issue for Australia from a risk perspective lies in the loans written before standards were raised and thresholds were lowered.

“It’s the water under the bridge that’s the risk,” Mr North said. “All of my analysis says the highest risk is not from loans being written today. It’s the ones written over the last three to five years. That’s because the underwriting standards were far too generous and the expenses side in particular were a problem.”

The mettle of these customers will be tested when rates begin to float back to “normal” — a term the RBA governor used on Thursday.

But there are problems with this line of thinking. For a start, the RBA may be forced to leave rates on hold for longer than it would like to due to this household debt issue. An issue that, in addition to stagnant wage growth, was driven by the easy availability of credit before the CFR stepped in to marshal some sort of order.

Whether or not order has been restored comes down to perspective. Affordability is a hot topic, but how much harder is it to borrow now than it was five years ago?

Sydneysiders and Melbournians who jumped into the market before the regulators did will be sitting pretty, provided they haven’t used their homes as ATMs and taken advantage of cheap debt. Let’s hope their incomes have risen accordingly.