Treasurer Josh Frydenberg isn’t getting any support from the Reserve Bank for his argument that the banks should not apply responsible lending laws “too stringently”.
Frydenberg said in a speech last week: “The risk that the provision of credit may cause substantial hardship to some should not result in a significantly reduced ability to access credit by the vast majority of borrowers.”
However, in its latest Financial Stability Review, published on Friday, the RBA says “improvements in bank lending standards over recent years reduce the risk that lower interest rates will see an unsustainable increase in household debt.”
In other words, the RBA believes that tighter lending standards are keeping a lid on risky lending at a time when rates are at historic lows. It is expecting lenders to keep implementing more detailed expense verification and imposing new debt-to-income limits, whatever the Treasurer might say.
The RBA also says the reduced share of lending at high loan-to-valuation ratios and on interest-only terms over recent years has limited the share of mortgages in negative equity.
It says: “The cumulative effect of measures to strengthen lending standards has been to reduce maximum available loan sizes, which means borrowers will have larger buffers to use in the event of future increases in their expenses or declines in income.
“Improvements in lending standards have significantly increased the capacity of borrowers who have taken out loans in recent years to service their debts relative to previous cohorts.”
The Financial Stability Review says that over the past year the household sector has faced continued low income growth and a decline in wealth due to falls in housing prices. Given high household debt, these developments had the potential to diminish the financial resilience of households.
There have been some signs of increased financial stress, especially in regions experiencing more difficult economic conditions.
Arrears on housing loans have continued to rise, particularly in Western Australia and the Northern Territory, but overall remain low in absolute terms and by international standards.
“Strong employment growth, very low interest rates and improvements in lending standards over recent years have supported these outcomes,” the FSR says.
“Overall, households remain well placed to service their debt. The most indebted households are those with the highest incomes, and many sizeable prepayments.”
Housing credit growth has slowed since mid-2017, with growth in both investor and owner-occupier ending at multi-decade lows.
The RBA’s liaison with lenders and mortgage brokers indicates that housing applications have decreased over the past couple of years, with little change in the rate of loan approvals.
There have been signs of a pick-up in the number of both loan applications and approvals more recently, but with housing market turnover remaining low, credit growth has also remained low.
In July, APRA changed its guidance on the interest rate floors and buffers that banks use to assess a borrower’s ability to repay a residential mortgage. Lenders were previously reqired to apply the higher of an interest rate floor of at least 7 per cent or the interest rate plus a buffer of 2 per cent.
The new guidance removed the 7 per cent floor, with a requirement that banks set their own floor, and increased the buffer to 2.5 per cent.
The effect of these changes has been to increase the maximum loan size available to most borrowers. In practice only a small share of borrowers take out loans that are close to the maximum available to them, suggesting the overall impact on credit growth is small.
On the other hand, there has been an increased focus on verifying expenses and implementing changes to the Household Expenditure Measure benchmark, which has resulted in higher expense benchmarks.
Banks have also introduced policies limiting debt-to-income lending and increased the repayment rates used to assess prospective borrowers’ existing credit card obligations.
The estimated share of outstanding mortgage balances in negative equity has increased to around 3.75 per cent – up from just over 2 per cent a year ago. Over half of all loan balances in negative equity are in Western Australia and Northern Territory.
Declines in income have historically been a key reason for households defaulting on their loans. Although the bank’s [RBA’s] central forecast is for the unemployment rate to remain broadly unchanged for some time, if the unemployment rate were to rise te risks associated with negative equity would increase.