How low rates are working their magic on debt

Low interest rates have pushed lending activity higher, but with many firms still choosing to deleverage and refinance rather than take on more risk, the country's debt burden is unlikely to expand rapidly.

Lending activity is on the rise due to historically low lending rates, but it remains well below its previous peak. Some firms are taking advantage of new investment opportunities but for many, low interest rates provide an opportunity to deleverage and refinance.

Commercial lending rose by 8.3 per cent in November, according to the latest data from the Australian Bureau of Statistics, although trend data suggests the pace of monthly growth has slowed since May. Nevertheless, as the graph below shows, the value of commercial lending activity is growing at its fastest pace since the global financial crisis began.

Graph for How low rates are working their magic on debt

Growth in commercial lending has been mainly driven by fixed lending facilities, while revolving facilities continue to lag behind. The same can be said for personal lending.

Personal loans rose by 0.6 per cent in November, but the trend remains fairly subdued. On a trend basis, personal lending has increased by 6.5 per cent over the year – in stark contrast with both business and housing loans. Revolving personal credit – such as credit cards – has been particularly weak and is down almost 25 per cent since its peak in March 2010.

Graph for How low rates are working their magic on debt

So far, the rise in lending activity has not resulted in a great deal of growth in outstanding loan balances. There are several potential reasons for this.

First, despite rising significantly in 2013, commercial lending activity is still around 25 per cent below its trend peak in December 2007. New loan activity is stronger than it was following the onset of the global financial crisis, but it remains quite weak compared with the past.

Second, many firms continue to deleverage and are also paying off their loan balances from periods when lending activity was much higher. Both ensure there is a high level of repayments.

Third, refinancing activity – which is considered a new loan but does not increase outstanding credit – has proved popular while interest rates remain so low.

Business credit outstanding fell modestly in November and is just 1.9 per cent higher over the year. The strength of lending activity suggests that business credit will begin to expand at a faster pace soon but for now it remains remarkably subdued by historical standards.

Graph for How low rates are working their magic on debt

Deleveraging should begin to subside soon and firms will begin to take on more risk. But refinancing will remain an appealing choice for businesses as long as lending rates remain so low. Firms would be silly not to try and reduce their interest burden while they have the chance.

The RBA will be quite happy that businesses are responding to low interest rates – it shows that rate cuts are having an effect – but at the same time they might be disappointed about the size of the effect so far.

“Monetary policy cannot force spending to occur,” Reserve Bank of Australia Governor Glenn Stevens said during a parliamentary testimony late last year. Instead it can only create incentives for businesses and households to bring the spending intensions forward.

We continue to see this fact in action. Low interest rates haven’t yet worked for everyone and many businesses – as well as households – remain especially cautious about the outlook. We should remember that interest rates were not set this low by mistake; it reflects the RBA expectation that the economy could be weak over the next few years and in need of considerable support to avoid a downturn.

There are many people out there who are concerned that loose monetary policy will result in a credit boom that could destabilise the economy. So far that hasn’t occurred, despite activity picking up for both households and businesses.

As long as deleveraging and refinancing remain a priority for so many, our debt burden is unlikely to expand at a rapid pace. As a result, the RBA will not be too concerned about leaving rates at such a low level.

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