The prudential regulator will not relieve borrowers of the 3 per cent interest rate buffer they must absorb before qualifying for a home loan because the economy faces too much uncertainty from inflation, geopolitics and leverage.
As Commonwealth Bank shares claimed a fresh record of $134.90 on Monday, Australian Prudential Regulation Authority chairman John Lonsdale said he was concerned risk in the financial system “remained elevated”, in a letter to lenders following a quarterly review of financial stability.
Major bank CEOs have sought relief from regulation. Louise Kennerley
Ahead of the Reserve Bank’s policy meeting next week – which may deliver another interest rate rise if the consumer price index comes in hot on Wednesday – Australian banks are trading at lofty valuations despite analysts warning of rising bad debts. CBA is more than 18 per cent higher over the year to date.
Holding fort on the buffer comes despite some major bank CEOs seeking relief from regulation to free up lending to households on lower incomes. Housing credit is expected to grow by around 5 per cent in 2025; APRA’s decision to maintain the buffer suggests it is not willing to allow loan growth to surge much higher than this.
While the level of loan arrears in residential and commercial lending remained relatively low, “it is slowly trending upwards”, Mr Lonsdale said.
“Given the uncertain economic and interest rate outlook, including the possibility of higher cost-of-living pressures, it is important that prudent buffers are incorporated in serviceability assessments,” he said.
The mortgage serviceability buffer at 3 percentage points forces banks to assess customers on an ability to repay borrowings at an annual rate of about 10 per cent given where home loans are priced.
Last month, ANZ boss Shayne Elliott said lending regulation was “locking out middle Australia” from being able to access credit.
APRA uses two other tools for macroprudential policy: the countercyclical capital buffer, which will remain at 1 per cent of risk-weighted lending, and limits on bank lending, which could cap credit growth in specific areas – but has not been applied.
Investors will get a read on credit quality when CBA reports full-year results on August 14.
APRA said on Monday the quality of new housing lending remained sound. While arrears rates on mortgage and business lending portfolios continued to worsen, they remained below pandemic peaks.
“Looking across the economy, we can see that credit growth for home purchases has moderated from its heights during the pandemic and is now a little below its long-term average,” Mr Lonsdale said.
“High debt-to-income and high loan-to-valuation ratio lending make up only small proportions of new lending.”
Fund managers point to Australian banks’ better capitalised balance sheets leading to lower loan losses through the cycle.
Atlas Funds Management said Australian residential property could be viewed as expensive globally, but it “sees a range of factors that strongly incentivise households to maintain mortgage payments”, in a note to investors at the weekend.
These include recourse lending, homes being exempt from capital gains tax, and a strong cultural desire to own a home, “which means that bad debts should remain quite low”, said Atlas chief investment officer Hugh Dive.
But Macquarie analyst Victor German said last week that, with the odds of the RBA achieving a soft landing diminishing given stubborn inflation, there was a risk the market would reassess abnormally low impairment charges if interest rates remained elevated.
Morgan Stanley analysts on Monday said the elevated share prices of the major banks pointed to a complacency around bad debts, “creating a low probability but high-impact risk to the downside”.
So far this year, the big four banks have delivered returns of between 16 per cent and 33 per cent to investors. But that means the potential benefit of improved net interest margins, reduced competition for mortgages and a soft landing are already baked in to market valuations.
The Morgan Stanley report suggests depositors will lose out if the RBA cuts rates. “In our view, a materially better funding mix and modest mortgage growth prospects leave the majors in a better position to manage deposit pricing than in the past.”
Current market pricing implies a 25 per cent chance that the Reserve Bank will lift the cash rate from 4.35 per cent to 4.6 per cent by September. However, traders believe if the RBA does not lift rates by November it may be cutting as soon as December.
The market is implying that there is a 10 per cent chance that the cash rate will be 25 basis points below its current setting at 4.10 per cent by the end of the year, a 25 per cent chance of a cut by February 2025, while a rate cut is fully priced in for May and two cuts are priced in by the end of next year.
APRA will continue to monitor bank lending standards.