Financial Stability Review
- Reserve Bank (RBA) warning: “…risks in housing and commercial property markets are rising in association with fast price growth in some cities, heightened investor activity and strong price competition among lenders.”
- Bank performance: “The Australian banking system has performed strongly since the previous Review. Banks’ profitability remains robust, supported by a further steady improvement in asset performance.”
- Household stress: “Indicators of household stress are currently at low levels, but could start to increase if labour market conditions weaken further than currently envisaged current interest rates.”
What does it all mean?
- As would be expected, the Reserve Bank has given Australia’s financial system a clean bill of health. But that doesn’t mean that it is not without its risks. Lenders are competing heavily for housing and commercial property assets, and the Reserve Bank has effectively warned lenders not to get over-excited. The Reserve Bank also warns that there is the risk of too many homes being built in some areas, such as inner city Melbourne. If investors and lenders alike are sensible then there are few broader concerns for the economy. But the Reserve Bank has made pointed warnings about risks in apartment markets.
- While most observers believe that financial system risks lie with the housing market, the RBA has focussed on risks in commercial property. Despite weak lease conditions, commercial property prices continue to rise, underpinned by strong demand from domestic and international investors. As a result, the RBA concludes: “the risk of a large repricing and associated market dislocation in the commercial property sector has increased.”
- While some economists may disagree, the Reserve Bank is comfortable with the debt position of households. In fact the RBA notes that strong position of the aggregate mortgage buffer (balances in offset and redraw facilities) standing at “more than two years’ worth of scheduled repayments at current interest rates”.
- While the household debt to income ratio is near record highs, net household wealth is also near record highs while household saving is historically high.
What does the report say?
Australian Banks:
- The RBA noted: “The Australian banking system has performed strongly since the previous Review. Banks’ profitability remains robust, supported by a further steady improvement in asset performance.”
- “…some banks recently applied stricter criteria for some inner-city apartment markets and certain mining-exposed regional towns.”
- ‘Conditions in domestic deposit markets have continued to ease over the past six months, contributing to a further decline in Australian banks’ overall funding costs.”
Housing:
- The RBA has warned of the risk of “oversupply in some regions, particularly in the inner-city areas of Melbourne and Brisbane.”
- “Ongoing strong speculative demand would tend to amplify the run-up in housing prices and increase the risk that prices in at least some regions might fall significantly later on.”
- Box B in the report outlines the responses from the Australian Prudential Regulation Authority (APRA) and Australian Securities and Investments Commission (ASIC) on housing lending practices.
Business sector:
- “Gearing levels are low by historical standards, and indicators of financial stress have continued to decline.”
- “…the aggregate gearing ratio of listed corporations remains near its historical lows.”
Household sector:
- “Indicators of overall household financial stress remain low, aided by low interest rates and rising asset prices.’
- “…some further increase in financial stress among households in mining exposed areas could be expected.”
- “Indicators of household stress are currently at low levels, but could start to increase if labour market conditions weaken further than currently envisaged.”
Commercial property:
- “Risks also appear to have increased somewhat in the commercial property sector, including property development. Search for yield behaviour has underpinned strong investor demand for commercial property assets, particularly from offshore investors, which has continued to drive prices higher and yields…”
- “Lenders should also be mindful of the collective effects of strong lending activity within particular market segments, even if individual borrowers appear to be of low risk.”
- “…the risk of a large repricing and associated market dislocation in the commercial property sector has increased. This could be triggered by several factors, such as growing excess supply that prompts a reassessment of valuations, or a sharp fall in foreign investor demand, perhaps due to a rise in global interest rates or weaker conditions in foreign investors’ home countries.”
- “Banks’ exposure to commercial property as a share of their total assets has fallen substantially since the financial crisis, and has remained stable over the past year However, with lending to this sector picking up, and reports of strong competition among lenders leading to some relaxation of lending standards, this is an area that will likely require close scrutiny for some time to come.”
Inner-city Melbourne:
- Some apartment markets, particularly in inner-city Melbourne as outlined earlier, also look vulnerable to potential oversupply, partly because apartment construction is subject to the same supply lags that affect other commercial property development. While investor demand appears strong at present, including from foreign investors, vacancy rates in these areas are relatively high and future tenant demand, including from international students, is uncertain. The current high rate of pre-sales should provide developers with some level of protection against a downturn in these apartment markets, but this protection is somewhat untested in an environment of falling prices, when investors might have the incentive to sacrifice their deposits and walk away. It is also unclear how foreign banks and developers – both of which are quite active in apartment markets on the eastern seaboard – would react to falling prices in these markets.
- The Financial Stability Review is published by the Reserve Bank every six months. The report is basically a health check on the financial sector but it also assesses the state of household and business balance sheets.
- Reading between the lines, the Reserve Bank is warning that further cuts in interest rates are not without their risks. There are already areas of concern to watch and another cut in rates increases risks that problems in the financial system may spill over into the broader economy.
- Financial stress is low and bank balance sheets are in good shape. So the latest Financial Stability Review underlines the strength of the Australian financial system in a global context.
- Commercial property has been a ‘sleeper issue’. But now it should be very much on the radar screen of investors, policymakers and analysts. The RBA says “At this stage, the near-term risks to the domestic financial system from the commercial property sector seem relatively modest, though they are building.”
- Investors in banks and other financial institutions need to keep a close eye on developments in property markets. Housing risks are centred on inner city Melbourne and inner Brisbane while commercial property risks are focussed on Brisbane, Perth and, to some extent, Canberra.
What is the importance of the economic data?
- The Financial Stability Review is published by the Reserve Bank every six months. The report is basically a health check on the financial sector but it also assesses the state of household and business balance sheets.
What are the implications for interest rates and investors?
- Reading between the lines, the Reserve Bank is warning that further cuts in interest rates are not without their risks. There are already areas of concern to watch and another cut in rates increases risks that problems in the financial system may spill over into the broader economy.
- Financial stress is low and bank balance sheets are in good shape. So the latest Financial Stability Review underlines the strength of the Australian financial system in a global context.
- Commercial property has been a ‘sleeper issue’. But now it should be very much on the radar screen of investors, policymakers and analysts. The RBA says “At this stage, the near-term risks to the domestic financial system from the commercial property sector seem relatively modest, though they are building.”
- Investors in banks and other financial institutions need to keep a close eye on developments in property markets. Housing risks are centred on inner city Melbourne and inner Brisbane while commercial property risks are focussed on Brisbane, Perth and, to some extent, Canberra.
