Property lending limits loom

Rather than raise rates, the RBA is likely to follow other central banks and tighten lending controls for property.

Summary: When it comes to controlling property prices, there are several ways to skin a cat. Raising interest rates is a very blunt tool, and that’s not on the Reserve Bank’s agenda. More likely is that the RBA will follow other central banks and use lending restrictions to tighten access to credit.
Key take-out: For property investors and for the near-term, this is probably the best outcome. Given that investors typically have higher net wealth and, in most cases, higher incomes it is unlikely that this segment will face tighter credit conditions.
Key beneficiaries: General investors. Category: Property investment.

Notwithstanding a slight and likely temporary slowing in the pace of house price growth, the outlook for property is outstanding. 

Exceptionally cheap financing rates and a persistent lack of supply, not to mention an unemployment rate much lower than policymakers had expected, will continue to provide significant support for this market.

At this point the Reserve Bank of Australia remains unconcerned about price gains. The RBA governor noted only last week that “some recovery was not in itself particularly cause for concern, certainly not initially. Moreover, if we think there is a need for higher construction, which we do, an environment of declining prices is probably not conducive to that outcome.

“Some pick-up in housing prices as a result of lower interest rates was to be expected; it shows that monetary policy is working and is part of the normal transmission process.”

Another reason the RBA isn’t concerned about the extent of house price growth is because the ramp-up in prices (10% on average in the capital cities) hasn’t been accompanied by rapid credit growth. Sure, current annual growth of housing credit at 6.2% is up from a year ago – 4.7%. But it is still less than half the average. 

That’s all well and good, and the fact is, the planets are aligned for ongoing strong house price growth over the next few years – in many countries another housing boom is underway! Noting this, the RBA will have to do something about it at some point. House price inflation builds its own momentum. But the question is, what?

To date, most nations have engaged – and the global debate has centred around – the need for ‘macro’ and ‘micro’ prudential controls. This is simply a more complicated way of saying more regulation – whether that be directed at an institution (micro) or the system/sector as a whole (macro). The RBA doesn’t see any use in the distinction between macro and micro by the way, and I think that’s right. In any case, we know the tools that would be – are being – used. Despite all the various terms and labels that are thrown around, there are really only two – restrictions on lending or higher (or more liquid) capital. Nearly all of the labels themselves describe one of these two in some guise – capital requirements or buffers, leverage ratios, debt-to-income limits and loan-to-value limits etc.

The Basel III requirements tend to deal with capital issues – quality, quantity and liquidity – and so, in practice, additional measures taken by central banks have tended to focus on some sort of lending restriction. Thus far:

  1. The Reserve Bank of New Zealand – Last year the bank decided to limit the proportion of bank loans with a loan-to-valuation of more than 80% to 10% of new lending.  
  2. The Bank of England – Will restrict the proportion of loans that are 4.5 times the borrower’s income to 15% of new lending – to take affect from October.  Lenders are also required to assess a borrower’s capacity to absorb a 3% interest rate hike in the first three years of the loan.
  3. The Bank Of Canada – Since the GFC, Canadians banks have had to reduce the maximum repayment period from 40 years to 25 years. Owner occupiers must have a minimum 5% deposit (up from 0%), while investors must have a 20% deposit. Limiting the total debt servicing burden to 44% of income among other measures.
  4. The Bank of Norway – Has increased the amount of capital that banks need to put aside in making residential mortgages. In effect, it has placed a higher risk-weighting on residential mortgages, lifting it from 10-15% to 20-25%.
  5. Other central banks, from Sweden to Israel, also have taken measures

What is more likely in Australia?

The latest input from the RBA shows that, as an institution, it is opposed to a marked lift in regulation, especially ‘macro prudential’ regulation. Both the RBA and APRA have contented themselves simply with warning banks against higher risk lending or a marked drop in standards.

They prefer the ‘telephone’ and ‘microphone’ approach, as the RBA’s head of financial stability termed it. In effect, the RBA and APRA think that having regular conversations with banks boards, regular stress testing and public and private announcements – or warnings should suffice.  That’s not to say that regulators don’t have capital standards, they do. As a minimum, banks must have a total capital ratio of 8%, a tier one ratio of 6% and a common equity tier one ratio of 4.5%. There are also provisions for capital conservation buffers, countercyclical capital buffers and they must have sufficiently liquid assets to cover themselves under a severe stress scenario for 30 days.

If that were the end of it, then I think it very unlikely that we would see additional macro prudential controls – or lending restrictions in Australia. But that isn’t the end of it. There is a reason why central banks around the world are increasingly relying on regulation to control their housing markets. They don’t want to hike interest rates! There is a currency war going on and Australia is in the thick of it. It’s the main reason why our cash rate sits at 2.5%. Noting this, I think it’s very unlikely that, should lending growth accelerate, policymakers would, firstly sit there and do nothing, or secondly, raise rates. Already the RBA is trying to jawbone the $A lower again and unless the major central banks have actually hiked rates – the RBA board would be loath to hike rates themselves. They’ll be faced with a choice ultimately. To let the currency surge higher or impose lending restrictions. Like other central banks, I think they’ll try lending restrictions first, notwithstanding the reluctance to do so. As politicians have noted many times before – the RBA doesn’t set policy.

What is better for investors?

For property investors and for the near-term, this is probably the best outcome.  Have a think about what other regulators have done. They either limit high loan-to-value ratios or loan-to-income ratios, but they don’t prohibit them. All lending restrictions do is make banks a little more judicious in handing out loans with high LVRs etc.  Given that investors typically have higher net wealth and, in most cases, higher incomes it is unlikely that this segment will face tighter credit conditions.

The fact is that most investors are less risky for a bank than first home buyers (who typically have lower net wealth and lower incomes). Certainly non-performing loans on bank balance sheets are lower for investors than owner occupiers. In the meantime, the move toward regulation ensures that rates will remain lower for longer.