According to Heidi Richards, General Manager, Industry Analysis Australian Prudential Regulation Authority, housing loans now make up nearly two-thirds of Australian ADI loan portfolios, compared to less than one-quarter of the total even as recently as the early 1990s. So it stands to reason that, despite “property busts” being a favourite media topic, the market really is too big to be allowed to fail.
In a speech at a recent Macquarie University Financial Risk Day conference, Ms Richards claimed that Australia has never had a real housing market downturn since the advent of the modern era of mortgage banking. It’s certainly not something that we should hope for!
“Historically, housing markets generally did not generate major losses for banks around the world until recently,” said Ms Richards.
“In fact it has been said that housing finance was one of the ‘villains’ of the global financial crisis. But was the relaxation in lending standards evident in the subprime lending episode really villainous, or was it a predictable financial credit cycle of the sort that has been played out over decades, if not centuries?
“Even before the financial crisis, it was well established, and certainly reflected in the academic literature on banking lending behaviour, that bank lending standards vary systemically over the financial cycle. Standards generally loosen over the course of prolonged good times and tightening once the economy has fallen into a downturn.”
Australians (and their institutions) are conservative
Everything is relative and when compared to overseas peers, it’s apparent that Australian financial institutions are reasonably conservative when lending – something that certainly held us in good stead during the GFC.
Ms Richards noted, though, that there are good reasons for regulators to assume that lending standards will be affected by the push and pull of credit cycles (aka booms and busts).
“We view it as our job to remind, motivate and if necessary dictate that banks maintain prudent lending standards even at the peak of a credit boom, when competitive pressures are often more intense. Setting some basic risk management expectations that can’t be competed away can help arrest the momentum of a race to the bottom for lending standards,” Ms Richards said.
Praise for our collective conservatism was echoed at the conference by Luci Ellis, Head of Financial Stability Department, Reserve Bank of Australia (RBA).
“Anecdotally at least, across a wide range of domains, it seems that Australia, as a society, chooses more safety than the average industrialised country does,” she said.
She noted that Australia has also seen less financial instability than average.
“The last serious banking crisis here was in the 1890s,” she said. “We came close to crisis in the early 1990s. Some of the banks were distressed and this clearly dragged on economic performance at the time. In fact, the early 1990s was the time of the last really serious recession in Australia. Though I wouldn’t regard the last 25 years as a period of entirely uninterrupted expansion, the downturns that did occur were brief and shallow. Many Australians now in the workforce have never known anything other than relatively benign economic conditions. Although growth has been below average in recent times, we are a long way from being in the kind of downturn that some countries have experienced in recent years.”
Have banks relaxed their lending standards?
Lending standards are the specific criteria lenders use to decide whether or not to grant a loan, such as:
- Can the borrower service the regular payments of interest and principal?
- Is there adequate collateral in the event the borrower defaults?
- Are there other factors in the borrower’s history that would affect the granting of a loan?
Whilst it’s impossible to predict something such as job loss, or the death of a partner, or some other catastrophic event that can impact on a household’s ability to repay a mortgage, APRA nevertheless notes that prudent lending standards are an important driver of the ultimate risk of a loan because they ensure some cushion for unexpected events.
One measurement for lending standards is the loan-to-valuation ratio, or LVR.
“A higher LVR at origination of the loan increases the risk that the borrower’s equity will be eroded to zero during any period where house prices soften,” said Ms Richards in her address.
“An LVR of say, 80 per cent, means there is a reasonable (though not huge) margin above the loan amount to absorb any house price falls. An LVR of 90 per cent or even 95 per cent means there could be very little, if any, buffer to cover costs in a default and repossession situation.”
The good (and not surprising) news is that whilst prior to the global financial crisis, we saw loans at LVRs of over 95 per cent, or even 100 per cent, being routinely offered, during and after the crisis, many ADIs tightened up on their LVRs, in some cases capping them at 90 per cent or lower for some types of borrowers or properties.
“More recently, APRA’s initiative to rein in growth in the investor segment of the market has prompted a number of ADIs to use LVR caps as a lever to reduce loan approvals in this segment,” said Mr Richards.
Ms Richards also noted borrower debt servicing ability as the other important element of the lending standards picture. Serviceability is essentially the calculation of whether a borrower can afford the repayments on a loan, after other expenses and income are taken into account.
“To look at how ADIs assess this, we have begun collecting loan-to-income breakdowns (LTIs),” she said.
“These data indicate that mortgage lending at four times gross income is relatively common, at one-third of all new ADI housing loans. Lending at six times or more of gross income is much smaller but still material – nearly 10 per cent.”