APRA must act on investor lending

Unless APRA takes an aggressive approach to investor lending, there is a real risk that rate cuts will drive property prices higher while undermining the business sector.

Property investors continue to drive credit growth across the country. Lending otherwise remains quite muted -- although there has been a modest pick-up in business credit -- reflecting the high existing stock of credit and the subdued outlook for the Australian economy.

Housing credit rose by 0.6 per cent in December to be 7.1 per cent higher over the year. Growth continues to be concentrated among investors, with credit outstanding to this segment rising by 10.1 per cent over the year to December.

Investor activity is now rising at its fastest pace since February 2008. That might give the impression that this level of speculative activity is not particularly unusual, especially given the graph above, but readers should remember this growth is coming off an exceedingly high base.

As a general rule, the higher the stock of existing credit compared with GDP or income the greater the potential systemic and financial risks at any given level of credit growth. In the absence of a lengthy period of deleveraging -- such as that which occurred in the United States and Europe -- the Australian economy is unlikely to experience credit growth of the magnitude achieved in the 1990s and early-to-mid 2000s.

APRA tends to agree and they have established a range of rules to monitor lending activity within the investor segment. Back in December, APRA said in reference to investor activity that "growth materially above a threshold of 10 per cent will be an important risk indicator for APRA supervisors in considering the need for further action". That threshold has now been breached.

The word ‘materially’ clearly indicates that there is scope for discretion. APRA is also assessing investor lending on a bank-by-bank basis. Some banks have probably been reckless, others less so. Given the concentration of lending among the big four banks, there is a good chance that at least a couple of them will be asked for a ‘please explain'.

Credit growth to owner-occupiers continues to grow at a more moderate pace, rising by 5.6 per cent over the year to December. Given mortgage approvals appear to have peaked -- the number of approvals is down by 4.5 per cent since January -- it appears as though credit growth to this segment may have peaked.

Credit outstanding to owner-occupiers accounts for almost 40 per cent of total credit, while investors account for a further 20.8 per cent. The total share of credit to the housing sector has increased from 45 per cent in 2000 to 60.75 per cent in December 2015.

Credit growth to the business sector has begun to pick-up in recent months and is now 4.8 per cent higher over the year -- the fastest pace of growth since March 2009. But lending activity to the business sector -- the flow of new credit as opposed to the stock of existing credit -- has slowed considerably over the past year. 

If monthly lending activity has peaked -- and at this point it appears likely -- then there is a very real risk that the rebalancing of the Australian economy will stall. As it stands, the current composition of Australian lending does not appear to be conducive to strong economic growth or sufficient to rebalance the economy.

Bank lending isn’t the only way in which businesses can expand, but it is often the only way in which small businesses can survive and thrive. It’s also a significant source of financing for larger corporations. This is one of the key reasons why there has been mounting support for further interest rate cuts, but that approach isn’t without its risks.

Unless APRA takes an aggressive approach to investor lending -- contrary to its historical approach to regulation -- we run the risk that further interest rate cuts will simply benefit the property market, bidding up house prices and continuing to undermine the business sector. In order to rebalance the Australian economy, that trend must be reversed -- the sooner the better.