Household debt is at a 25-year high, but regulators say risky loans haven't increased significantly.

Household debt is at a 25-year high, but regulators say risky loans haven't increased significantly.

Central banks from Scandinavia to the UK to New Zealand are sounding the alarm about soaring mortgage debt and trying to curb risky lending. Here in Australia, where borrowing is surging, regulators are just watching.

Australian household debt is at a 25-year high, according to statistics bureau figures, and a government inquiry this month found housing to be a significant source of risk to the financial system. The average mortgage is at least four times household income in almost 80 per cent of the country, research by Digital Finance Analytics shows.

While the UK, Denmark and New Zealand introduce measures including loan limits, caps on interest-only mortgages and repayment tests, the Reserve Bank and the country's banking regulator are holding their fire, saying risky loans haven't increased significantly. The central bank also has said the price gains so far are spurring needed construction, easing housing shortages in some areas.

Household debt is at a 25-year high, but regulators say risky loans haven't increased significantly.

Household debt is at a 25-year high, but regulators say risky loans haven't increased significantly. Photo: Virginia Star

"If we think there is a need for higher construction, which we do, an environment of declining prices is probably not conducive to that outcome," RBA Governor Glenn Stevens said in a speech in Hobart earlier this month. "Some pick-up in housing prices as a result of lower interest rates was to be expected."

Overvalued Housing

Australia has the third-most overvalued housing market on a price-to-income basis, after Belgium and Canada, according to the International Monetary Fund. The average home price in the nation's eight major cities rose 16 per cent as of June 30 from a May 2012 trough, the RP Data-Rismark Home Value Index showed.

In Sydney, where price growth has been strongest, home values soared 15 per cent over the past 12 months. That compares with a 5.4 per cent increase in New York City in April from a year earlier and a 26 per cent jump in London prices in June quarter from a year ago.

"There's definitely room for caps on lending," said Martin North, principal at researcher Digital Finance Analytics. "Global house price indices are all showing Australia is close to the top, and the RBA has been too myopic in adjusting to what's been going on in the housing market."

Residential Construction

Our regulators are hesitant to impose nation-wide rules as only some markets have seen strong price growth, said Kieran Davies, chief economist at Barclays in Sydney.

Home values in cities including Adelaide, Hobart and Canberra rose less than 3 per cent over the year to June 30, and house prices in areas outside the major cities gained less than 4 per cent in the 12 months to May, according to RP Data.

The central bank has reduced its benchmark interest rate to a record-low 2.5 per cent to aid a recovery in non-mining industries, including residential construction, as the resources boom slows.

The interest rate cuts and subsequent home price gains have helped building approvals climb 14 per cent in May from a year earlier, according to the Australian Bureau of Statistics.

Necessary Evil

"The RBA's probably got at the back of its mind that we're only in the early stages of the adjustment in the mining sector," Davies said. "Mining investment still has a long way to fall, and also the job losses to flow from that. So to some extent, the house price growth is a necessary evil."

The central bank in its quarterly monetary policy update called declining resources investment a "significant headwind," for the economy.

As prices climb, the value of new mortgages also rose 16 per cent in May from a year ago, and overall housing credit increased 6 per cent in the quarter ended March 31 from 12 months earlier, statistics bureau data show. The average new home loan grew 6.7 per cent to $433,960 in June from a year ago, according to broker Australian Finance Group, which processes about $4 billion in home loans every month.

The increase in new mortgages, while significant, doesn't appear "imprudent," Stevens said in his speech in Hobart. With total credit growth only slightly above the increase in incomes, "it's hard to mount the soap box to complain about that pace," he said.

Low Rates

Spurring the rise in loans are the lowest mortgage rates in almost five years, after the RBA cut the cash rate by 2.25 percentage points since late 2011. The average rate on variable mortgages, which about 85 per cent of Australians borrowers are on, is 5.95 per cent, the lowest since September 2009.

Fixed rates are also on their way down. The Commonwealth Bank, National Australia Bank and Westpac last week cut their five-year fixed rates to 4.99 per cent, a record low for CBA, the least in 20 years for NAB, and a five-year low for Westpac. Australia and New Zealand Banking Group. reduced its five-year fixed rate by 30 basis points to 5.49 per cent.

Rising Debt

Stevens this month urged investors in Sydney to be cautious, after loans to buy rental properties in New South Wales surged 30 per cent to a record $5.2 billion in May from a year ago, doubling from February 2013, according to statistics bureau data. He also warned that loans to investors covering more than 80 per cent of a property's value have been climbing.

Australians owed almost 1.8 times their 2013 pretax disposable incomes, higher than Canada, France, Germany, Italy, Japan, the UK and the US, the statistics bureau said in a report last month. Household debt was equivalent to $79,000 per person at the end of 2013, and has risen at almost double the pace of assets over the past 25 years, it said.

Government Inquiry

Since 1997, when Australia held its last major financial system inquiry, household debt has almost doubled as a proportion of income, with more than 90 per cent of that due to housing, the government inquiry found. Mortgages account for two-thirds of banks' loan books, from 47 per cent in 1997, it said.

"A large enough disruption to the housing market could have significant implications for household balance sheets, financial stability, economic growth, and the speed of recovery in household spending and broader economic activity following a shock," the inquiry's report said.

New Zealand's central bank last year required loans for more than 80 per cent of a property's value to account for less than 10 per cent of a bank's new lending. In response, home sales fell 11 per cent between October and March.

Global Measures

The Bank of England last month proposed capping mortgages of 4.5 times a borrower's income at no more than 15 per cent of a lender's new home loans, and required banks to reject those who fail a new repayment test. Governor Mark Carney in May called surging home prices the No. 1 risk to the economy, and Deputy Governor Jon Cunliffe this month warned low borrowing costs hide the real extent of Britons' mortgage burden.

Denmark's central bank is pushing to require interest-only loans to be no more than 60 per cent of a property's value, from 80 per cent. In Sweden, lenders are in talks to require borrowers to cut mortgage debt to less than 70 per cent of home values, and have capped borrowing at five times household income.

'More Stretched'

Across Australia, the average mortgage is at least four times pretax annual income in more than 2200 postal codes out of a total 2800, according to Digital Finance Analytics. Loan- to-income ratios are spread between 2.5 times and 8 times, compared with 0 and 6 times in the UK, the data show.

"So the loan-to-income ratio in Australia is more stretched than in the UK," DFA's North said.

The RBA, in response to an e-mailed request for comment, referred to speeches and papers by Head of Financial Stability Luci Ellis.

The Australian Prudential Regulatory Authority, which oversees banks, in May issued draft guidelines urging lenders to conduct mortgage book stress tests, ensure brokers' compensation doesn't encourage risky lending and ascertain borrowers can repay loans, especially when rates rise.

"APRA is seeing increasing evidence of lending with higher risk characteristics and it does not want this trend to continue," the regulator's former chairman, John Laker, said in a statement then.

Requests to large lenders' boards for explanations on how they're monitoring risk have already led to more prudent standards, APRA Chairman Wayne Byres told a parliamentary hearing on July 18. Andrew McCutcheon, a spokesman for APRA, declined to comment further.

Shifting Stance

While regulators haven't yet introduced firm lending controls, their resistance to such measures has softened. The RBA's Ellis in October 2012 said she didn't see a need for "elaborate" rules, and "a culture of cooperation, dialog and mutual respect" is more important than formal arrangements. In contrast, Stevens said after his speech in Hobart that the RBA is "quite happy" for limits on lending and capital requirements on banks to be imposed where they make sense.

The RBA and APRA have acknowledged potential benefits of loan limits "but at this stage they don't believe that this type of policy action is necessary," said David Ellis, a Sydney-based analyst at Morningstar Inc. "If the housing market was out of control and if loan growth, particularly investor credit, grew exponentially then it'd be introduced."

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