Australia Debt Binge Could Put Economy at Bigger Risk

Reserve Bank of Australia Governor Phil Lowe has warned Australian banks have been issuing too many loans “where the borrower has the skinniest of income buffers”, in a speech that highlighted increasing concern among the nation’s top financial policymakers about household debt levels.

Lowe said that while households “are coping reasonably well with the higher debt levels”, the low levels of wages growth are making it hard for people to get ahead on their mortgages, stretching household budgets, Business Insider reported.

He said the foundations of the surge in house prices had been laid by supply shortages and a failure to invest in infrastructure, but that this had been exacerbated by the offering of interest-only loans to investors and by the tax treatment of such investments.

Lowe revealed the combination of higher debt levels and rising house prices had been “discussed at length” by the Council of Financial Regulators, the high-powered committee which Lowe chairs as the RBA governor and also includes the heads of treasury, the banking regulator APRA, and the corporate regulator, ASIC.

Household Debt Mounting

“The concern has not been that these developments have posed a risk to the stability of our financial system. Our banks are resilient and they are soundly capitalized,” Lowe said. “Instead, the concern has been that the longer the recent trends continued, the greater the risk to the future health of the Australian economy. Stretched balance sheets make for more volatility when things turn down.”

The remarks indicate mounting concern about the economic risks of the debt build-up on household balance sheets. "It gives some of the clearest insight we’ve seen yet about how the central bank sees the risks in the economy given the explosive house growth in Sydney and Melbourne over recent years."

Lowe’s speech, to a dinner hosted by the RBA in Melbourne last night, came hours after the RBA’s monthly interest rate statement noted the labor market has been showing signs of weakness recently, while also noting the increased focus of the banking regulator on lending standards.

Lowe said: The level of household debt in Australia is high and it is rising. Over the past year the value of housing-related debt outstanding increased by 6½%. This compares with growth of around 3% in aggregate household income. The result has been a further rise in the ratio of household debt to income, from an already high level.

In aggregate, households are coping reasonably well with the higher debt levels. Arrears rates remain low and many households have built up sizeable buffers in mortgage offset accounts. At the same time, though, slow growth in wages is making it harder for some households to pay their debt. For many people, the high debt levels and low wage growth are a sobering combination.

Strain in Consumer Sector

While Australia’s economic growth rate has been relatively healthy, there have been some recent signs of strain in the consumer sector. Official data from the Australian Bureau of Statistics showed retail sales volumes contracted slightly in February, for example, and the unemployment rate has ticked up from 5.7% to 5.9%.

Lowe went on to comment on what he said was Australia’s “unusual” environment for property lending and its associated tax incentives.

Over the past year, close to 40% of the housing loans made in Australia have not required the scheduled repayment of even one dollar of principal at least in the first years of the life of the loan; only interest payments are required. This is unusual by international standards.

There are a couple of factors that help explain the popularity of interest-only loans in Australia. One is the flexible nature of Australian mortgages. Many people with interest-only loans make significant payments into offset accounts rather than explicitly paying down principal. This flexibility, which is of value to many people, isn’t available in most countries.

A second factor is the taxation arrangements that apply to