RBA warns against poor lending practices

Speaking at the University of New South Wales' Real Estate Symposium in Sydney yesterday, Luci Ellis, the Reserve Bank of Australia head of financial stability department, warned that the Australian financial system risks forgetting about past mistakes when it comes to the relationship between property markets and financial stability.

“I don't want to sound flippant about this, because history does tell us that it is possible to forget good credit risk management,” Ms Ellis said.

“One of the things we risk forgetting about property markets and financial stability, and about risk more generally, is that it is possible to forget.

“As we get further away from the peak of the crisis, increasingly we will hear points of view questioning what the fuss was all about. If there is indeed a trade-off between growth and financial stability – and that's by no means settled – policymakers must balance both considerations.

“In doing so, they must not forget the full costs of financial instability and the distress it can cause.”

In particular, Ms Ellis said, it is possible to forget “how to do good credit risk management”. While she admits that the body of knowledge about best practice in the area “has certainly expanded over the past quarter century”, that doesn't mean it is always practiced.

“It is all too tempting to ease standards over time,” she said.

“It is like one of those humorous verb conjugations: ‘I am just responding to strong competition; you have relaxed your standards; he is being imprudent’.”

Credit risk management was forgotten to some extent in the US mortgage market during the GFC, as it was often new (non-bank) firms doing the lending, Ms Ellis said.

“Without an existing corporate culture about risk, often without a prudential supervisor to enforce those standards and practices, without ‘skin in the game’ in the form of their own balance sheet absorbing that risk, the new wave of US mortgage lenders slid inexorably into a stance of utter imprudence,” she said.

Ms Ellis also warned that we risk forgetting that property markets are not just about households' mortgages.

Property development, including for residential property, and commercial lending related to property more generally, should also receive sufficient attention from risk managers, policymakers and academic researchers, she said.

“It is these segments of lending that tend to grow in importance in the late stages of a boom, and to account for a disproportionate share of loan losses in a bust.”

While previous literature has pointed to property finance, or home loans, as the driver of credit cycles, Ms Ellis said she would be wary of making this assumption too readily.

“Some recently released empirical analysis suggests that, for the United States at least, it is unsecured corporate borrowing that drove the cyclicality in business credit in recent decades, not (commercial) mortgages and other secured credit, which seems more or less acyclical.”