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You can't bank on banks

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It’s time we saw regulatory reform so home ownership can still be an attainable aspiration for Australians. To achieve this, banks should be determining the risk of lending money, not regulators.

Tim Reardon

Chief Economist, HIA

The winding back of consumer credit reforms is a very small piece of the regulatory reform needed to ease household’s access to finance. Not only was easing of access to finance central to Australia’s recovery from the 1990’s recession, it is also essential for sustaining the dream of home ownership.

Since the Global Financial Crisis (GFC), the government and regulators have adopted a ‘belt and braces’ approach to regulation – despite the lack of evidence of a problem – in the pursuit of an ‘unquestionably strong’ financial system. 

This decade of red tape has reduced risk but it has come at a cost. This cost is borne by first-time home buyers who are being forced out of the market, which is contributing to the decline in home ownership. 

Lower interest rates have made repaying a mortgage easier now than at any time since the 1990s, but the banks’ deposit requirements have become increasingly onerous. 

Residential mortgages are deemed to be significantly more risky today than prior to the GFC. Since 2008, authorised deposit-taking institutions (ADIs) have increased their capital as a share of total risk-weighted assets from 10.5 per cent to 15 per cent. This means that it is simply more expensive for banks to lend to first home buyers now than it was prior to the GFC. This risk-weighting is more significant for loans such as interest only loans, loans to investors, loans with high loan to value ratios and loans in riskier geographic areas. 

Just in case this wasn’t enough, the Australian Prudential Regulation Authority (APRA) reviewed its Prudential Practice Guide for Residential Mortgage Lending in 2014, 2016 and 2019 – at each step making it harder to lend for the purchase of a new home. Compared with the pre-2014 guide, the guidelines in the 2019 edition are considerably more stringent. ASIC added further to the regulatory burden.

From the start of 2018, a credit crunch commenced. The time taken to assess a home loan went from two weeks to two months and the number of clients rejected for finance doubled. All this risk aversion, despite no evidence of the risk.

Banks need to be able to determine the risk of lending money to individual borrowers, not regulators

Banks must now apply much greater scrutiny on the income and living expenses of applicants; there are tighter criteria for assessing loan serviceability buffers; lenders are required to discount non-salary income (such as rental income, bonuses, overtime etc.) when establishing an applicant’s income; there are more restrictive criteria for assessing applications for interest-only loans; and guidelines were added for mortgage lending to self-managed super funds.

This credit crunch was the primary cause of a 20 per cent decline in the number of homes under construction between the end of 2017 and 2019. It also led to a decline in home ownership rates as banks increasingly lent to households that already owned a home. 

Since 2009, the share of loans issued to customers with a 10 per cent deposit or less has fallen from 21 per cent to less than seven per cent. The high point in 2009 coincides with the boom in first home buyer activity in response to the GFC stimulus measures. The ability to access finance with a high LVR was a factor that assisted many first home buyers to enter the market. This is no longer an option for most. In addition, lending to buyers with an LVR between 10 and 20 per cent dropped from 20 per cent of new lending to 15 per cent of new lending. 

Just as the post-GFC stimulus caused a rise in first home buyer participation in the market, the post-COVID first home buyer incentives and HomeBuilder grant have also led to a cyclical rise in first home buyer activity. In the absence of these initiatives, and as their impact on the market declines, the structural problems will become increasingly evident.

These reforms over the past decade in residential mortgage lending have been successful in creating an ‘unquestionably strong’ financial system. Lenders have increased their capitalisation, they have cut back lending on terms that are perceived to be high risk and they managed to implement temporary measures to lean against a property boom. 

The problem is that in the pursuit of this ‘unquestionably strong’ financial system, the regulatory squeeze has forced the banking sector to eliminate much of the flexibility in the mortgage market that made home ownership achievable. Lenders have been forced to increase their capitalisation and as a result they have cut back lending on terms to buyers with a 10 per cent deposit. They are perceived to be high risk despite the presence of mortgage insurance and their demonstrated capacity to service a mortgage.

Ensuring that home ownership remains an attainable aspiration for Australian households should be an equally important objective. To achieve this outcome requires banks to determine the risk of lending money to individual borrowers, not regulators. 

The repeal of consumer credit provisions, known as responsible lending guidelines, is a very small part of the regulatory reform task needed to ease household’s access to finance.