The Reserve Bank has highlighted the conservative financial behaviour of households in recent years. The Bank concludes that “Few households appear to be vulnerable to falling into mortgage arrears.”
The RBA also warned of the challenges posed by the multi-speed economy, noting that the corporate insolvency rate “may be closer to its 2009 peak” with “pressures on those sectors not benefiting from the resources boom” and noted the tight financing conditions being experienced by property developers.
What does it all mean?
It is clear from the latest report card that Australia’s financial system is in reasonable shape. But there were also a few ‘ifs’ and ‘buts’ expressed by the Reserve Bank. Mortgage arrears have come down, but Queensland now dominates the regions with highest arrears rates. Business failures are also up, especially in “business and personal services” sectors. And smaller property developers are under pressure due to “ongoing tightness in financing conditions.”
It is in the interests of governments, the Reserve Bank and property market participants more generally to address the tightness of credit conditions in housing and commercial markets. Rental housing markets in particular are tight, pointing to the need for more building of apartments and houses.
Bank profitability has come in for further scrutiny, but the Reserve Bank concludes that return on assets is in line with the pre-crisis average. Further, the Reserve Bank has flagged softer bank profits ahead, reflecting weaker credit growth and a bottoming in bad debts.
By cutting debt and new lending, Aussie households and businesses are better placed to deal with challenges ahead. But there will be challenges, especially those thrown up by the multi-speed nature of the economy. As the Reserve Bank notes: “there may be a larger than usual segment of poorly performing firms; it is the connections of these firms to the financial sector that are most relevant for financial stability.”
Selected comments from the Financial Stability Review
- Europe: Improved sentiment and conditions
“Since late December, there has been a notable turnaround in global financial market sentiment reflecting actions taken by the European Central Bank (ECB) to support euro area bank liquidity and other policy steps to address the sovereign debt problems in the region.”
“Bank capital positions have been strengthened substantially since 2008, improving the resilience of the major banking systems compared with their pre-crisis standing.” - But risks remain
“Even though market confidence has improved, risks to global financial stability remain: financial systems are susceptible to any further setbacks in dealing with the sovereign debt problems in Europe, and the near-term outlook for growth in the major advanced countries is subdued, which could affect the outlook for banks’ asset quality and profitability.”
“…it is not clear if banks that have borrowed heavily from the ECB can transition smoothly back to market-based funding over the next few years.” - Australian Banks: funding
“…the banks have been able to make significant inroads into their expected wholesale funding requirements for the year, and thereby put themselves in a better position to cope with any renewed funding strains, should they occur.”
“Deposits have also been continuing to grow faster than credit, reducing the size of banks’ wholesale funding task.” - Australian Banks: profits
“In annualised terms, the average return on equity in the latest half year was about 16 per cent, slightly higher than in the same period a year earlier, and broadly in line with the pre-crisis average.” - Australian Banks: profit outlook
“While the banks continued to record robust profits in their latest half-year reporting periods, the slow credit growth environment is likely to limit the pace of future profit growth, particularly as the reductions in bad and doubtful debts that had boosted profitability in recent years appear largely to have run their course.”
“Given that banks’ non-performing assets remain elevated, their future profit growth could be reduced if the current stock of provisions is insufficient for future losses.” - Australian Banks: risks
“…(asset performance) remains weaker than in the years leading up to the crisis. If economic conditions were to deteriorate materially, this would mean that banks are in a less favourable starting position in terms of their asset quality than a few years ago.” - Lending & credit conditions
“According to industry liaison, lending growth is expected to remain at similar levels for some time due to subdued demand for credit.”
“In industry liaison, most banks reported only modest interest in lending for commercial property, with credit standards generally remaining tight.” - Bank funding mix
“The strong growth in deposits has allowed banks to reduce their use of short-term wholesale funding further over the past six months. In early 2012, the deposit share of bank funding reached its highest level since 1998, at 52 per cent. In contrast, the share of short-term wholesale funding has declined to 20 per cent, compared with 33 per cent at the end of 2007.” - Households
“In aggregate, households are managing their debt levels well, though mortgage arrears rates are still a little higher than a few years ago.”
“Although the household sector as a whole is still quite indebted, it remains the case that there is only a small share of very highly geared borrowers, and households generally appear well placed to meet their debt obligations.”
“…aggregate indicators of financial stress show that the household sector has been coping reasonably well with its debt level.” - Mortgage arrears…up in Queensland
“Queensland – particularly the areas in the south-eastern part of the state that rely on tourism, such as the Gold Coast and Sunshine Coast, and where unemployment is higher than the state average – is now more heavily represented among the regions in Australia with the highest mortgage arrears rates.”
“Few households appear to be vulnerable to falling into mortgage arrears.” - Lower wealth, has led to higher saving
“Real net worth per household is estimated to have fallen by 6½ per cent over 2011, to be 11½ per cent below its 2007 peak. This contrasts with the rapid trend expansion in this series over the decade to 2007 when average annual growth was 6½ per cent.” - Improved home affordability; tight rental markets
“At the national level, the ratio of dwelling prices to income has fallen over the past year, and is below the average of the past decade, while rental yields have begun to pick up, assisted by stronger rental growth as well as lower prices.” - Businesses
“Overall, profitability and conditions in the business sector are positive. However, banks’ non-performing business loans and failure rates are somewhat higher than average, reflecting the challenges some firms are facing as the Australian economy goes through a period of structural change.” - Business credit
“Internal funding of non-financial corporates increased to 11 per cent of GDP over the nine months to September 2011, the highest level in over 20 years.”
“…liaison suggests that appetite for new debt remains subdued, and some businesses reported paying down existing debt.
“Although liaison indicates that the availability of bank finance has improved over the past year for many firms, credit conditions remain tighter than prior to the crisis, particularly for loans to property developers.” - Commercial property
“Despite conditions in the commercial property market improving, construction activity remains below average. This partly reflects ongoing tightness in financing conditions.”
What is the importance of the economic data?
The Reserve Bank releases its Financial Stability Review twice a year. The FSR is an assessment on financial conditions and a check on the health of the financial sector.
What are the implications for interest rates and investors?
The Reserve Bank hasn’t been effusive in its language about the strength of the financial system. While banks, households and businesses are generally in good shape, they are by no means bullet proof. Property developers are finding it hard to get credit, mortgage arrears have lifted in Queensland and Western Australia and corporate failures have lifted for a number of non-mining sectors.
The Reserve Bank clearly has left the door open to further rate cuts, acknowledging the difficulties being experienced by a raft of households and businesses.
Aussie consumers have the ability to spend if they want to with saving levels at historic highs and with so many well in front with mortgage payments.