Transcript of Question & Answer Session The Housing Market and Financial Stability

Thanks so much for that, Michele, that was very, very topical and newsy, and hopefully of great interest to everyone who's watching. So what we're going to do now is I'll have a sort of a fireside chat with Michele for a period. I've already got some questions coming in from the audience. Please feel free to submit questions. I can't say that I'll get to all of them, but I'll try and do my best there. I just wanted to open up, Michele, you talked about tools that address the serviceability of loans and the amount of credit that can be obtained by individual borrowers. What would those tools look like in real life here in Australia?

Thanks, Michael. So I think if we look overseas, there's quite a number of examples of the sorts of tools that might be considered and in fact have been actively used in many other countries. Things that address serviceability are quite important, so the types of tools that have been used overseas include interest rate buffers to assess serviceability. At the moment, the way that banks have to assess serviceability is they have to include a certain buffer over interest rates to make sure that people do have the ability to meet, continue to make repayments in the event interest rates rose. In other countries, they introduced bigger buffers, so that's one possibility.

A second possibility are things like debt to income ratio. So some countries have put in what we call portfolio restrictions. So they would say you can't make more than X percent of loans with debt to income ratios over say, 6. Another tool that's being used overseas, even in our near neighbour's, New Zealand, a loan to valuation ratio. So again, the concept is that you might say banks can't make more than X percent of their loans that have loan to valuation ratios over say, 90%. So these are the sorts of tools and some countries use them in combinations, but I think they're the sorts of tools that we would also be looking at in the Australian context.

I just wanted to ask you about the average assessment to determine borrowing capacity. If I'm right, it's at about 5.4% now, it was 7.3% I think a couple of years ago. I mean, are you comfortable with that level? I mean, it's hard to imagine the RBA or any central bank raising rates by 3 percentage points, in at least recent times, that certainly hasn't been about. So is 5.4%, does that seem okay to you?

At the moment, I mean, it's not so much at the moment that we have a floor rate. So let me just go back one step. There used to be a floor rate which APRA had set, and that floor rate looked reasonably high relative to what interest rates were doing at the moment and in the context of a low inflation environment. So if we were going to introduce an additional buffer here, it would be not so much saying that interest rates could rise by X percent.

So it's not essentially saying central banks are going to raise interest rates by X percent, but what it would be effectively doing is saying we want consumers to have a bigger net income surplus, a bigger buffer, above their loan repayments than they currently have. So it would be a sort of a device to achieve that. So I wouldn't read so much into it as saying, "This is what we think interest rates are going to do." It's more saying, "This is a tool we're going to use to ensure that people's net income surplus is increased."

I just wanted to also ask you about the 6 times borrower's incomes, I was just looking at some data yesterday and it looks like about a fifth of new loans are being approved at levels at that 6 times rate, this is according to second quarter data, which is obviously generally viewed as high risk. I mean, is that at a level that starts to become a problem, or are we still some way off from that becoming an issue?

I think it's another example where aggregate numbers sometimes miss a little bit of what's going on. So yes, it's something that we are alert to and watching. A couple of mitigating factors, though, on the one hand there, with the increase in turnover there seems to be a little bit of bridging loans going on. So people are buying, getting a bridging loan and selling, which increases debt to income ratios, so it's not necessarily increased risk. The other thing is that investors, when they're starting to come on back into the market and they tend to have high debt to income ratios, but they're not necessarily more risky to banks.

And I guess the final thing I would say there is that often, people with high debt to income ratios actually have high incomes as well. So there are people on low incomes who have high debt to income ratios, they're riskier than people on high incomes that have high debt to income ratios. So there's movement within the aggregate that we're watching and I think just watching the aggregate by itself doesn't tell you anything. In summary, I'd say yes, we're watching it, but there are some things going on there that are suggesting to us that we shouldn't be necessarily alarmed at the moment.

Got you. Just talking about the amount of turnover in the bridging loans, obviously it makes sense to buy a house before you sell it when prices are moving so quickly. What sort of impact do you expect the lockdown, particularly in Sydney and Melbourne, to have on the property market? And perhaps an extension of that, what sort of impact do you expect the lifting of the lockdown to have? Because presumably you're going to have more properties coming to market, which perhaps dissipates some of the intensity of bidding on individual properties.

Yeah. So I think we've seen signs that the lockdown in Sydney and Melbourne has dampened activity somewhat. It hasn't had the same impact, I think, as the first lockdown. I think there has been some adaptation, both of sellers and buyers and the real estate industry itself, but we have seen things coming off. What's going on in the market at the moment is reflecting, I think some fundamental shifts in demand. As I highlighted, we've seen regional areas also increasing in value, we've seen detached housing being in particular, quite elevated, less so high density which hasn't been doing quite as well. So there's been some shifts in lifestyle and preferences, which are impacting. And I would expect some of those things, after lockdown finishes, to start coming back into the equation again. But at the same time, there's also lack of population growth and in particular, a lack of students and those sorts of things.

So there's that demand element that currently isn't there and that often impacts on the high density area. So there's lots of moving parts at the moment, and so I would say that I think things will probably pick up a bit where they left off. Turnover will spring back, I think. People will start to put things back on the market again, and I think what will be interesting to watch is what happens with the high-density sector, if population growth starts to move up again, but at the moment, that is not being impacted.

Michele, you also mentioned investors there too. Obviously, we're not back at what we saw last decade, but are there any worrying signs with the investor borrowing that you're coming across?

Not at this stage. They are coming back into the market as we would expect, and having investors in the market is not a bad thing, as I mentioned earlier, investors own the rental stock in Australia. So it's clearly very important that there is rental stock out there for people who aren't purchasing homes or can't afford to purchase a home, that they've got good rental stock available. I think what was going on in 2014 and '17, when investor lending was growing by over 10% a year, I think there were concerns that it was amplifying the housing cycle. So that was the concern there. At the moment, we're seeing them come back a bit and there's nothing alarming in that yet, but it's something that we'll keep an eye on.

So we're not looking at tighter restrictions on investor lending, that's not on the horizon in this moment?

That's not on the horizon at this stage. As I said back in 2014 and '17, the focus was on investor lending and on interest-only lending. And at the time it was more about microprudential standards that APRA was interested in, it was interested in the banks, it was interested in how the banks were dealing with the lending standards and the growth in their portfolio. So it had a very microprudential focus at the time on the institutions. I think what we're talking about now, as I tried to outline in the prepared speech, was that the banks themselves are solid. What we're more interested in now is the build-up of debt in the household sector and the potential implications of that for the economy and what we call macrofinancial stability.

Makes sense. Just looking internationally, I mean, South Korea has raised interest rates to cool asset prices and New Zealand's likely to hike next month, again, in part to try to cool housing. Do you feel a bit hamstrung, given that the RBA has made it fairly clear that it's not going to be using monetary policy to lean into asset prices because there are wider issues at stake, obviously. I mean, does that make your job that much tougher?

Well, I guess that's why we're having a conversation about what we broadly call macroprudential measures. Around the world, that's basically, I think now accepted that the monetary policy really should be addressing the macroeconomy broadly. And if we do have financial stability concerns, then we should be looking to these other tools to try and address those concerns. I think I'd just reiterate what the governor said, which is that at the moment, monetary policy is really needed to get unemployment down and inflation up and I don't think we can afford to be distracted from that. But other countries have demonstrated and it's increasingly well accepted that these sorts of other tools can assist in addressing some of these financial stability risks or vulnerabilities.

You mentioned in your speech about our elevated household debt to income ratio. I mean, it's been fairly stable for a while, but you presume it's going to rise from here. I mean, does that add to the risk for households, and in turn consumption, when interest rates eventually do start to normalize?

Yes. It impacts directly obviously, because if interest rates rise, you've got less money to spend. But to the extent that that was built into the lending standards and interest rate buffers, you won't necessarily need to curb your consumption, but the evidence suggests that people do anyway. And they do tend to, whether it's precautionary or whether they are constrained, they do tend to, when they are highly indebted, reduce their consumption, when recessions happen.

So even if they don't lose their job, they might tend to amplify those consumption impacts by doing so. So that's really what we're focusing on. What are the potential vulnerabilities building? As you highlighted, the debt to income ratio hasn't really risen over the past few years. I think though that if we continue to see if credit is growing much more quickly than income for the next few years, then that ratio is going to rise and those concerns about the potential vulnerabilities of household balance sheets will start to come to the fore.

I'll just ask one more and then there's a couple of audience questions as well. In some other countries, it's the central bank that controls macroprudential policy. Is it an issue for you that it's APRA that actually holds that responsibility? I mean, you sort of don't have the interest rate lever, and then you're having to negotiate with someone else, I guess, to try to work out how to do that.

No, it doesn't. There's a variety of models around the world in this. And I think in our case, yes, APRA is the authority that's responsible for these sorts of tools. Because macroprudential tools and microprudential tools, they're sort of the same thing in many ways, but really the difference is where you're directing it. Are you directing it, as for example, in 2014, and '17 to the banks themselves and their balance sheets, or have you got something broader in mind? So, it doesn't concern us. We've got an extremely good relationship with APRA, we work closely with them through the Council of Financial Regulators, which is an appropriate forum to do this and other countries have similar models, and I think it can work very effectively.

I'll ask an audience question here, this is on the rental market. The question is, does the RBA have modelling on domestic rentals? The yields have dropped significantly as risk-free rates reduce, but does the RBA believe that would likely be much less elastic if rates rose again?

Well, we don't have modelling on the rental market per se, what we have done quite a bit of modelling on is the sort of rent buy equation. When does it make sense to buy and when does it make sense to rent? And if you look at those models, that would suggest at the moment that if you take into account the lowering of interest rates, actually it makes sense, housing prices aren't necessarily that far over value. So they're sort of in reasonable line with fundamentals in that sense. Now, does that suggest that when interest rates rise, the equation may reverse? Yes, it may, in which case you would expect yields to rise and investors to come back into the market. So all these things, that's why I said earlier that investors aren't a bad thing in the market. We need them because they do provide the rental stock, but these things go a little bit in cycles.

I think when you do see interest rates rise, that might reverse and that might sort of change the rent buy equation, and that is going to end up affecting yields and that in the end will end up affecting investment decisions by investors. So yes, what goes around comes around in a sense, but there can be lags. And the problem with property sometimes, particularly high-density property, is it takes a little while for the building to happen. And in the meantime, you can get sort of rents rising a bit more quickly than they would otherwise. At the moment, there doesn't seem to be an issue with supply of high density, but you never know, that could reverse.

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And another one here, do you have any concerns over concentration of residential lending on certain maturities? For example, the impact of the RBA's TFF on the fixed mortgage market?

Yeah, interesting question. So this has been a question that we've looked at in the past as well, and the concern that we might have, and what we're focusing on really, is when people come off these fixed rates, will they get sort of interest rate shock, in some sense? And that'll affect their ability to meet their repayments. In the past when we've looked at this, what we've been able to glean from this sort of information we have in particular, some of the disaggregated data is that most people do have reasonable buffers. And so when they do come off those fixed rate loans, they actually can meet their repayments. And there's only a small portion that can't.

I think given the way that the interest rate buffers have been implemented so far, in terms of the lending standards and the way APRA's requiring them, I would expect that that would still be the case. Having said that, that is something that we will be carefully monitoring to make sure that we're alert to any issues of interest rate shock coming off those fixed rate loans. Because they are at very low levels, as we know, so the interest rate buffers that have been applied to those is going to be a very important mitigant.

This is quite an interesting one as well. How closely is the bank working with APRA to assess Chinese property sector risk, given the active role now played by mainland banks with many Australian communities?

Well, APRA obviously is the prudential supervisor. So we don't get involved in the individual banking supervision aspects. Our interest from a financial stability perspective is more, as I said, on the system-wide aspects. At the moment, I would say that probably the system-wide impacts of those banks is not something that's overly of concern for us, but I would expect that if APRA did have those sorts of concerns, we would be talking with them, but very much the prudential side and the individual side is their bailiwick.

Got you. Just wanted to raise this one with you, Michele. The labour market's showing quite a lot of Australians are working second jobs at the moment and part of that, I guess, might be people filling positions that were once occupied by temporary migrants, obviously they're not around now. But just that nature of people running two jobs or more, I mean, does it raise concerns about just how precarious people's sources of incomes are when we're talking about meeting mortgages and these sort of things, or are they likely to just be young people and not such an issue?

I don't have any particular insights, I don't think, on that specifically. I would say that that sort of information and verification of income is the sorts of things that bank lending standards is all about. And when APRA's working with the banks to ensure that they're maintaining the lending standards, the sorts of questions they'll be asking is how are you verifying income? How are you verifying how precarious that income is? So whether or not these are second jobs, are they casual jobs? These sorts of things will all come into that equation.

And I would say, if anything, over the last few years, the banks have really increased their verification and their processes for making sure that they understand this sort of thing about people's income. So it may well be, that there is more of this going on at the moment, I don't know, but I suspect that it's not really impacting people who are getting loans as such, because lending standards will be to some extent ensuring that people aren't in precarious situations because of their income.

Okay. So I'll make this the last one. And I'll just bring it back to the financial stability review, which is obviously coming out in just over two weeks. Your last one in April was obviously a time when the economy was recovering rapidly, COVID appeared contained. Outside of property which we've talked about quite a lot, what areas or have any areas changed significantly or anything else come to the fore in the intervening period, obviously with the quite dramatic change in circumstances we've seen in that time too?

I think the main thing is that at the time, I think we felt back then, that with the economy recovering, that household balance sheets and business balance sheets were in a very good position. I think what's happened since obviously, even though we've got government support again, and that's helping both on the business and the household side, the vulnerability of household balance sheets and business balance sheets still remains a key issue and because the economy is, I think that what we're talking about now is delayed, not derailed, but nevertheless, the longer it goes, the more risk there is that some of the businesses won't recover. That will have implications for banks, but also have implications for households themselves.

With financial stability, it's always a bit of a balance. I say that I worry, no matter what happens, I'm worrying if things are growing too quickly and I'm worrying if things are in downturn. So my worries have shifted from, are things going too quickly and are vulnerabilities building there, to are balance sheet's going to be impacted and therefore, are we going to see some of the vulnerabilities actually come to light? So I think that would be the main way in which our thinking has changed a little bit since we last wrote it in April.

On that note, I think we'll wind up there. Thank you so much for your time, Michele. You've been very generous in taking so many questions as well and I hope for our audience, you've gained some knowledge from that on what is a very, very topical issue at the moment. We'd normally have a round of applause for Michele, but you just have to imagine it really here, don't you? But yes, thanks very much for joining us, and we'll see you on the next Inside Track.

Thank you. Thank you everyone.