Published by Australian Financial Review, Friday 31 March
APRA has moved to tighten the rules around bank lending for investor purposes. This takes us back towards the old, post-war regulation of banks where the regulator imposed direct controls over both sides of banks’ balance sheets. Since reform of the financial system in the 1980s, the trend had been towards general and market based tools to manage the system, but now the trend is clearly back towards direct controls.
In its note to the banks, APRA initially explains this was a decision taken in conjunction with the other regulators. Clearly the most important of these was the Reserve Bank. With overall investment in the economy growing slowly, the RBA would be very reluctant to raise interest rates by as much as might be needed to dampen growth in property lending. A significant rise in interest rates, coupled with the current spike in energy prices, would run the risk of flattening the economy. In this context, the decision to raise the direct barriers was the only real alternative for a regulator determined to slow housing investment.
So it was the right tool, but was it the right decision? Clearly APRA is worried about the exposure of banks to the property market. As a prudential regulator this is fundamental to its brief. Looking at the data published by the banks it’s hard to be as concerned as APRA appears to be. Most borrowers seem to be well able to cover their financial obligations, even if there were to be a significant rise in rates.
Most households are months ahead on mortgage repayments and have quite high levels of equity in their properties. Interest-only borrowers are clearly different but there are few apparent signs of stress.
There are two possibilities. Either the internal data that APRA gathers from the banks is showing cracks appearing, or the move is largely pre-emptive. The latter seems most likely. After a long period of demand for property exceeding supply (particularly in Sydney and Melbourne), the market appears to be getting closer to equilibrium, and there is a prospect for the apartment market in some cities moving into excess supply. Stories are starting to appear that people who bought off the plan are having to sell properties at a loss. This may be a leading indicator of excess supply.
A switch from excess demand for residences towards excess supply clearly creates the precondition for a sharp fall in prices. As a prudent regulator, APRA seems to be ensuring the banks are well prepared in case that happens.
There is another important lesson from history. When banks are prevented from meeting market demand for a financial product, other institutions will step into the breach. When these are unregulated, or differently regulated, risk can be transferred to sectors which are less prepared to manage them. We saw this in the seventies and eighties with building societies, finance companies, and State banks.
The decision of APRA to limit the ability of banks to assist in this transfer of risk is also significant. A bank often warehouses a collection of mortgages for a non-bank, for a period. Once it is big enough the non-banks will sell the pool off to other investors. APRA has warned that it is now monitoring closely this sort of warehousing. It won’t stop all the non-bank activity, but the move is significant and may help slow the growth of the less regulated sector.