Home Finance Banking Sector in Australia on a Knife-Edge due to Housing Market

Banking Sector in Australia on a Knife-Edge due to Housing Market

by internationaldirector

Written By: Diana Bailey – Corporate Finance

In Australia, S&P Global Ratings just decided to downgrade the credit quality of 23 banks and lenders, including Australia’s biggest regional banks. The rating agency fears that the rise in property prices and the high level of household debt could lead, in an adverse scenario, to big difficulties for the Australian economy. House prices have continued to accelerate since the Reserve Bank of Australia (RBA) cut rates to a record low of 1.5 percent in August 2016. Low rates and booming population, especially in cities, have encouraged Australians to borrow and buy houses.

Looking at the graph below, published by the Reserve Bank of Australia in May, household debt has continued rising in conjunction with the rise in property prices.

Strong growth in private-sector debt is projected to increase to about 136 percent of gross domestic product (GDP) in June 2017 from 117 percent in 2013. The issue is that the disposable income of households is now growing at a slower pace. But Australians’ debt-to-income ratios are growing, sometimes rapidly.

As published in the RBA’s governor’s speech, “Household Debt, Housing Prices and Resilience”, the percentage of households that have debt amounts above 100 percent of their incomes is now high. Already by 2014, 20 percent of households had debts three times over their incomes. Those should be the “richest”, but the Reserve Bank of Australia has also revealed that more than 30 percent of borrowers have less than one month’s repayment buffers with their income levels to pay back their loans.

According to S&P, the risk of a sharp correction in property prices has increased. And in case of a downside scenario, all financial institutions operating in Australia would likely incur significant credit losses. Indeed, with residential home loans securing about two-thirds of banks’ lending assets, the impact of such a scenario on financial institutions would be amplified by the Australian economy’s external weaknesses, in particular its persistent current account deficits and high levels of external debt.

The five major banks keep their ratings due to strong support from the Australian government.

S&P Global Ratings reaffirmed their credit ratings for the big four banks (Westpac, Commonwealth Bank of Australia, ANZ, National Australia Bank) and Macquarie. This situation is strange, when put in light of those five banks’ large market share of the housing market. It seems to come from the idea that those banks are “too big to fail” and will be supported by the federal government. S&P, considering the past history, expects “timely support” from the federal government should those banks need it. However, the continuous rise in prices has continued unabated, despite the top banking regulator intervening twice in the last three years to cool the housing market and protect deposits.

At the moment, the Australian government has set a 6-percent tax on the four major banks’ funding transactions, expecting an extra $6.2 billion in tax revenue over the next four years. Those four major banks plus Macquarie hold an 80-percent share of the mortgage market. A 0.06 basis-points increase in the funding costs of the major banks is not something big per se. But the banks’ net-interest margins already declined in the last half of 2016, to an average of 2.01 percent from 2.08 percent a year earlier. Consequently, this cost could be passed on through borrowers’ interest rates and could participate toward cooling down the housing market.

But the point of view of the Reserve Bank of Australia is different:

The RBA’s governor, Philip Lowe, is not worried about the strength of Australian banks and the resilience of the Australian banking sector. According to him, stress tests confirmed the solid capacity of the banking sector to resist. The governor also does not think that Australia could face a sub-prime crisis like that of the United States, because the wealthiest have the most significant debts, assets have increased, and employment levels are still good. He is more concerned with Australia’s economic imbalances. What most worries Lowe is the decrease in consumption that will inevitably occur if households carry too much debt compared to their incomes. And, according to him, real-estate prices will cool down when big construction projects, especially in cities such as Melbourne and Sydney, are delivered and increase supply.

Whatever the considerations, rating agencies, the Australian government and regulators all have their eyes on the housing and mortgage markets.

The sharp increase in the values of dwelling commitments, as published by the Australian Bureau of Statistics, has started to stabilize.

For sure, both housing prices and increases in household debts in Australia are going to be scrutinised by the markets, the regulator and the government.


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