Reserve Bank of Australia

We’re now seeing a full-blown crackdown on home lending, with the Australian Securities and Investments Commission following hot on the heels of the Australian Prudential Regulation Authority to bring lenders (and mortgage brokers) to heel.

With data yesterday from CoreLogic showing house prices surging at unsustainable levels, there’s a real question about whether the regulators’ intervention will be enough, or whether it is too late. House values rose 1.4% across Australia in March, pushing annual price growth to 19% in Sydney and 16% in Melbourne. CoreLogic said house values in Sydney were now growing at their fastest yearly rate since November 2002, while growth across all capital cities is at a seven-year high of 12.9%. 

There’s still the Reserve Bank, though: its board meets today, and home lending, not interest rates, will be the big area of interest, especially its view on home lending and housing in Sydney and Melbourne.

On Friday, APRA wrote to banks establishing a new limit on interest-only loan lending when the borrower needs more than 80% of the value of the property (and warning that loans for over 90% are a major red flag) and demanding that banks make sure they are “comfortably below” APRA’s previously established “speed limit” of 10% growth in housing investor lending.

Yesterday, ASIC also took aim at interest-only loans, announcing it would be setting out to “identify lenders and mortgage brokers who are recommending high numbers of more expensive interest-only loans”. ASIC will also require lenders to:

“… individually review cases where consumers suffer financial difficulty in repaying their home loans, and determine whether they have been impacted by shortcomings in past lending practices. Where appropriate, consumers will be provided with tailored remediation, which may include refunds of fees or interest.”

Which sends a message to banks that if someone can’t repay a loan, the banks themselves might be on the hook for it, not the borrower.

Why target interest-only loans? APRA believes they’re higher risk loans (they also cost more, over the life of the loan), reflecting borrowers for whom a traditional principal-and-interest loan is too expensive in the short run, and they currently make up nearly 40% of new loans. You can bet a lot of those are for properties in Sydney and Melbourne, where prices are skyrocketing.

Will these measures, plus whatever efforts the RBA brings to the table, be enough? As we’ve been noting in recent days, this isn’t the first time regulators have had a crack at this. ASIC announced in December 2014 that it was looking at interest-only loans as part of a broader review by regulators into home-lending standards — because interest-only loans as a percentage of new housing loan approvals by banks reached a new high of 42.5% in the September quarter of 2014.

The same day in December 2014, APRA wrote to the banks indicating the growth in loans to property investors should not exceed 10%.  APRA said that to ensure that new borrowers were able to service loans when interest rates rise, banks should use a 2% interest rate buffer and a “floor” lending rate of 7% when assessing borrowers’ ability to service their loans.

That produced a slowdown in lending that lasted from mid-2015 into the latter months of 2016. But in December of last year and January of this year, investor loans easily topped the 10% limit, while interest-only loans headed back toward 40%. Now the regulators are using almost exactly the same language to complain about the same problems.

In 2015, ASIC was also unhappy with the efforts the banks are making to establish a potential borrower’s actual living expenses and thus their capacity to repay at both current future rate levels. It conducted a review that “found examples of practices that place lenders at risk of breaching responsible lending obligations” but now professes itself to be happier with things after banks had overhauled their practices.

So why the failure after 2014, and will the current moves have any more luck? Will we just be back here in 2020 with housing investor lending getting out of control again? The RBA has given us a clue who it thinks is to blame for the eventual failure of the 2014 measures, in the wording of the key paragraph in the minutes in the February and March minutes.

In the February minutes the final sentence read: 

“Supervisory measures had strengthened lending standards and some lenders were taking a more cautious attitude to lending in certain segments.”

That was shortened in the March minutes to read:

“Supervisory measures had contributed to some strengthening of lending standards.”

So no lenders were “taking a more cautious attitude to lending in certain segments”, the references to “strengthening” became qualified. Why did the regulators miss the build up in investment lending and wait until this year to move?

That doesn’t absolve the lenders involved (nor does it excuse the cupidity of Coalition governments, which allowed super funds to borrow, especially self-managed funds, and their refusal to address the way negative gearing and capital gains tax concessions subsidise property investment). If handled badly, a property collapse and the damage it inflicts on consumers and banks could end a quarter century of economic growth. The stakes are accordingly very high for the regulators getting it right this time.