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Household Debt a Key Concern

Rising levels of household debt are a key concern for Australia, with mortgage debt and unsustainable property investment two of the biggest risks to financial stability according to the RBA. While the central bank have expressed increasing confidence in the wider economic outlook, and seem in no rush to increase interest rates, domestic household balance sheets remain a real worry for policymakers. According to some commentators, stress tests by the RBA may lead to tighter lending restrictions and other prudential actions by the baking sector.

The RBA's Financial Stability Review was released a few days ago, with the overall tone of the semi-annual report noticeably more relaxed than it was six months ago. According to the RBA, holding the cash rate steady will help the bank to reach its inflation target and is consistent with sustainable economic growth. While current and prospective strength in employment is expected to support household spending in coming months, long-term growth and confidence continue to be constrained by slow growth in real wages and high levels of household debt.

According to figures from the IMF, Australia has one of the highest income-to-debt ratios in the world. While the IMF note that richer countries like Australia are more able to service large household debts, high debt levels make households more sensitive to increasing borrowing rates and risky lending practices. In reference to this, the RBA are making efforts to gain a broader picture of how credit losses, bank profits, capital ratios, and loan growth would be affected under an "adverse macroeconomic scenario". The stress testing that will take place will run in parallel with wider surveillance of the banking system by the Australian Prudential Regulation Authority.

According to the RBA, "Household indebtedness, most of which is mortgage borrowing, is high and gradually rising against a backdrop of low interest rates and weak income growth," with upcoming tests "consistent with the Reserve Bank's focus on risks affecting the whole banking sector, rather than bank-specific risks that are the focus of prudential regulators." The RBA also expressed concern with banking culture and the changing mix of the investor market, recognising "evidence that changes over time may be increasing risks, namely the rise in the share of households with multiple investment properties and in the share of investors over the age of 60 with mortgage debt, as well as investment across state borders where the investors' knowledge of the property market can be lower."

J.P Morgan economist Ben Jarman said the RBA's review was an unusual development that could lead to additional lending restrictions: "The wording is quite vague, and the motivation for conducting these tests is pretty unclear," Mr Jarman said, adding "It is not hard to imagine such simulations [stress tests] being used to support the argument that macro-prudential policy can be tightened further, without acting contrary to APRA's objective of raising capital ratios. The governor has repeatedly expressed discomfort this year with the fact that credit growth is still running materially above income growth, so despite progress made to date, it still seems fairly likely that further prudential actions are taken to cap, or at least restrict growth, in the household debt-to-income ratio."


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