Expert Advice with Simon Buckingham 24/01/2019
Following on from my last article on "Fixing the Credit Crunch", I was interested to see Australia's 5th largest financial institution, Macquarie Bank, come out recently with its own suggestions for a relaxation in lending policies.
I've argued previously that it's overkill to combine testing a borrower's loan servicing ability at a theoretical 7%+ interest rate (around 3% above current lending rates) with the extremely conservative approach currently being taken by many banks when assessing living expenses.
It seems like others are starting to come around to this view too.
Measures implemented by the financial regulators and the banks over the last 3 years have gone well beyond what was necessary to support stability in Australia's financial system, to the point where there is now increasing evidence that those measures are stifling the flow of credit in the economy - putting Australia's economic prospects at risk.
Risks Rising - But No Action Yet from the "Powers that Be"...
There's a growing awareness of the problem among Australia's Council of Financial Regulators (made up of APRA, ASIC, the RBA and the Federal Treasury).
In particular, both the Treasurer and the RBA have been making noises recently about credit restrictions posing a heightened risk to the economy, and are worried that some banks are being "overly cautious" in their lending decisions.
But they're yet to take genuine tangible action to address the risk.
It's a bit like Nero playing the fiddle while Rome burns. All talk and no action.
To be fair, APRA - the regulator that originally led the charge on tightening lending policies - has already backed-off both its 10% "speed limit" on growth in lending to investors and the 30% maximum it imposed on the proportion of new lending that was allowed to be on interest-only terms.
But this is unlikely to make a real difference to the availability of credit, as lenders in Australia have already been operating well below those thresholds for some time. According to the latest stats from the RBA, growth in lending to investors is currently at it's lowest rate in 30 years (increasing by just 1.1% over the last year).
So it's not the regulator's "speed limits" or thresholds that are the problem.
Rather it's the overly conservative implementation of loan servicing tests, and the "overly cautious" approach of the banks at the moment, that risk impeding a healthy flow of credit.
Will Interest Rates Come Down?
With concerns increasing about the outlook for the Australian economy, some analysts have begun speculating that the next move from the RBA on interest rates might actually be down.
Financial markets are currently "pricing-in" a 50-50 chance of a reduction in the cash rate later this year.
But other economists, such as Justin Fabo and Ric Deverell from Macquarie Bank, see little chance of a rate cut in 2019...
The Alternative: A Relaxation in Lending Restrictions
Rather than a reduction in interest rates, Macquarie's economists recently indicated that they think there's "a non-trivial chance" the regulators might instead relax some of the recent lending restrictions, in order to head-off a potentially damaging slowdown in credit growth.
In a note to clients, Fabo and Deverell suggest that the mandated minimum interest rate of 7% currently used when assessing borrowing capacity could potentially be reduced:
"A meaningful lever for APRA to pull is to reduce the minimum interest rate threshold at which lenders must assess a borrower's debt-servicing capability...
"While the average interest rate on new variable rate owner-occupier loans is close to 4%, and numerous products have rates below this, lenders must assess new borrowers at rates more than 300 basis points [i.e. 3%] higher.
"This APRA directive probably made a lot of sense 2-3 years ago when banks' serviceability assessments in other areas (e.g. on expenses) were lacking."
But in a low inflation environment, with anaemic wages growth and little upward pressure on either prices or interest rates, a 3% rise in interest rates over the next few years seems highly unlikely.
Furthermore, with lenders applying greater scrutiny of living expenses and having tightened loan applications in other ways, and with the greater risk now being to economic growth and employment rather than to financial stability, APRA could - to quote Fabo and Deverell - "sensibly justify" that the 7%+ interest rate test is too high.
What Would This Mean for Borrowers?
Even a reduction of half a percentage point in the interest rate test used for loan servicing could make a material difference - to both how many people who could access finance, and to how much they could potentially borrow.
For instance, at the current 7%+ theoretical interest rate threshold, someone on the 'average' Australian income of $82,000 with no debts, no dependants, and average living expenses might be approved for borrowing of around $350,000 on a home loan by most lenders without too much trouble.
If the interest rate test was reduced to 6.5%, then that same individual could potentially see their borrowing limit increase to over $380,000 - almost a 10% increase in borrowing capacity.
The resultant improvement in Australians' ability to refinance, access equity in their homes, or borrow to buy a home could then flow through into improved business and consumer confidence - resulting in more consumer spending, more business investment, more property investment, more construction activity... and improved support for economic growth and employment overall.
Is a Relaxation in Lending Imminent?
The approach suggested by Fabo and Deverell seems like a sensible risk-mitigation strategy, given emerging concerns about the impact tighter lending is having on consumer/business confidence and on key employment sectors such as construction, real estate, financial services and retail.
And there is mounting pressure on the Government and the regulators to do something to address the risks to economic growth and employment posed by a rapid slowing of credit growth in Australia.
So how quickly might we see a change?
That's hard to judge, as it depends upon how seriously the Government and the regulators take the risks posed by the recent tightening of credit.
Macquarie Bank's note to its clients stated that they "wouldn't expect a change anytime soon... But if the [Reserve] Bank and APRA reached the conclusion that lenders' overall loan serviceability assessments had tightened so much that they are unduly restricting the flow of credit, a rational first step would be to lower the interest rate floor."
Property investors will be keen to see what actually unfolds over the coming months, and we'll be closely monitoring any new developments.
Watch this space for more updates!
- Simon Buckingham
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Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.