Login
ISCOVER
Participants in the housing and mortgage markets are eagerly anticipating details of the much-talked-about ‘macroprudential instrument’ that the Reserve Bank of Australia and APRA may be looking to introduce in order to address the perceived imbalances in the current market, particularly with respect to the level and nature of investment loan activity in the Sydney and Melbourne markets.
Despite recent comments by senior representatives of both agencies that macroprudential instruments are really nothing new and shouldn’t be seen as the panacea to cure all real or perceived problems associated with the increase in home values in the past two years, this has not stopped an avalanche of media and industry speculation.
To continue reading the rest of this article, please log in.
Looking for more benefits? Become a Premium Member.
Create free account to get unlimited news articles and more!
Looking for more benefits? Become a Premium Member.
What are APRA and the RBA likely to do? What impact will any such intervention via a new macroprudential instrument have on the market?
Rather than focus on such industry and media speculation, the RBA and APRA are likely to have regard to a paper published by the Bank for International Settlements, the overarching body established to work with central banks around the world, based in Switzerland.
That paper, released in 2012, provides a useful guide to central banks when considering the selection and application of macroprudential instruments.
What does the report tell us about the likely macroprudential instrument outcome for Australia?
Let’s start from first principles. The paper defines a macroprudential instrument as follows:
“Macroprudential instruments can be defined as primarily prudential tools that are calibrated to target one or more sources of systemic risk such as excessive leverage, excessive liquidity mismatches, too much reliance on short-term funding or interconnectedness.”
What is the ‘systemic risk’ that the RBA and APRA are seeking to address in their current deliberations and what does the paper suggest is the most appropriate macroprudential instrument to address such systemic risk?
In summary, the RBA are seeking to ‘lean against’ the financial cycle to reduce the probability or magnitude of a future economic downturn, precipitated by a housing market downturn caused by (real or perceived) excessive optimism and speculative activity in the market, primarily in the form of investment activity in the Sydney and Melbourne markets. They are seeking to reduce the level of investment lending activity in those markets by either influencing the supply and/or demand for investment loans, so that they account for less than the current 50 per cent of new lending activity.
They may seek to do this in a number of ways (apart from general market commentary and targeted communications behind closed doors to lender management and boards). Three potential options that have received the most scrutiny are:
1) Directly addressing the supply of investment loans by putting a speed limit or quota on the amount of new investment lending that a regulated lender may undertake, as the Reserve Bank of New Zealand has done in New Zealand in terms of high-LVR loans
2) Imposing higher servicing restrictions on investment loans, either by way of higher interest rate buffers and/or putting a cap on the extent to which rental income may be utilised to meet minimum servicing requirements
3) Indirectly addressing the supply of investment loans by imposing higher capital requirements on investment loans, thus seeking to influence the cost of supplying (and potentially the cost to acquire) investment loans
One interesting point of reference is the development of low-doc loans over the past decade.
Up until 2008, when the GFC struck and the risks associated with low-documentation loans first materialised, the growth of low-doc loans in Australia had been very strong. By 2008, low-doc loans accounted for approximately 15–20 per cent of all new lending. Further, the interest rate differential between low-doc loans and full-documentation or traditional loans had eroded such that there was no material difference; that is, you could obtain a low-doc loan for roughly the same interest rate as a fully verified loan.
In 2008, APRA introduced some new prudential standards in conjunction with the implementation of Basel II in Australia. In doing so they introduced the concepts of a standard and non-standard mortgage. A low-doc loan was classed as non-standard and attracted a 50 per cent higher capital charge (or risk weighting) than a standard loan.
Whilst this development (in addition to the lessons learned from the US market meltdown) did impact both the pricing and reduced the amount of low-doc lending occurring between 2008 and 2010, it wasn’t until the commencement of the National Consumer Credit Protection Act that the amount of low-doc lending in the market materially slowed.
There are two questions for the RBA and APRA in considering option three above: what impact will higher capital charges for investment loans have on the supply and demand for investment loans, assuming this is one of the options they are considering? More broadly, is the likely market response sufficient to achieve the desired outcomes associated with the introduction of new macroprudential instruments, without other unintended adverse consequences?
