What are macro prudential controls & should investors be worried?

I guess, like every good thing, sometime it had to come to an end. Something is going to stop this property boom, which has been really quite strong in Sydney and Melbourne.

While most of us thought that it was going to be the Reserve Bank of Australia raising interest rates, things may in fact be slowed down by what’s called macroprudential controls, or high-risk lending.

I recently spoke with Michael Yardney about this on my Real Estate Talk show. He’s been researching this subject and has written some blogs on it as well.

Here’s the transcript of our interview:

Michael:  Hi, Kevin!

Kevin:  Michael, firstly, what are macroprudential controls?

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Michael:  This is a new buzzword at the moment, isn’t it? Everyone’s talking about it. What they are, are financial regulations aimed at minimizing the risk to the financial system as a whole.

In the past, people talked about microprudential controls, which limit stresses on individual banks and institutions.

In essence, we’re talking about measures that aren’t associated with raising interest rates, but things designed to slow down lending, particularly to property investors, and this could be policies like capping loan-to-value ratios or capping debt-to-income ratios, or stress-testing borrowers’ capacities to see how they’re going to cope if interest rates go up.

Kevin:  So why now, Michael?

Michael:  Property prices have been rising, particularly in Melbourne and Sydney, so the Reserve Bank and APRA, which is the organization that looks after prudential lending for banks, seem to certainly be trying to do something about it because house prices have gotten out of control is some areas.

And, in the Reserve Bank’s eyes, they’re not worried that there are problems now, but they’re worried if things keep going up, it could lead to a crash in the future, and that’s why they’re looking at maybe taking some control of what they potentially see as high-risk lending.

property moneyKevin:  Has this been tried elsewhere?

Michael:  Well, while we haven’t heard of it much recently, it definitely is something that happened many years ago before they deregulated banking in the 1980s.

However, the term became fashionable again after the GFC where lots of countries around the world have been doing this, especially developed countries like Asia, where they were worried about their financial system. More recently, it’s been occurring in Britain and New Zealand, and still in lots of countries around Asia.

Kevin:  How do they go about assessing this?

Michael:  Well, it doesn’t always seem to work. It’s difficult to assess whether it’s working.

Across the ditch in New Zealand, last year they decided to limit the proportion of bank loans with loan-to-value ratios of more than 80% to only 10% of new lending. In other words, they were restricting people who were borrowing large-ish amounts, hoping to stop speculation.

But despite that, Kevin, property prices in Auckland in particular — Christchurch as well — kept rising, so the Reserve Bank of New Zealand had to raise interest rates as well.

So maybe they’re not working as well as people expected.

Kevin:  Can’t they just get that big sledgehammer out with the RBA and just raise interest rates?

Michael:  Yes, they could, but increasing rates is, as you say, a sledgehammer. It’s a blunt instrument, and the fact is our economy is limping along at the moment and couldn’t take it.

If we raised interest rates, it would put a halt on the economy in general. On the other hand, macroprudential policies are seen by policymakers as a way of targeting specific segments of the market – in particular, property investments.

Kevin:  Has there been any feedback from the government on these issues?Houses-for-sale

Michael:  Yes. After the G20 meeting in Cairns, Joe Hockey came out, and he agreed that targeted and time-limited macroprudential controls could be a good idea.

Kevin:  Michael, do you think these measures are going to slow down the market?

Michael:  While they may do so in the short term, they probably won’t have the desired effect in the long term.

I know rising property prices have been blamed on ugly, greedy property investors, but there’s a lot more to it. I think there has been a combination of the Chinese economic revolution, which has fed our commodities boom and fueled our economy.

At the same time, there has been an immigration program that went gangbusters, and added a net one million people to our population in just about three years.

And then, despite that, there’s a general shortage of housing at a time of historic low interest rates, and all this together has pushed up our property values.

Sure, property investors have been part of it, but they’ve really only contributed maybe about 38% of the current value of new loans.

So even if the Reserve Bank targets  what they see as high-risk loans from property investors, there are still going to be the first-home buyers, the upgraders, the downgraders, and there are still going to be all those overseas investors, those hordes of people bringing money in, fueling our markets with it, particularly the off-the-plan and new markets. So I’m not sure that doing this is going to slow our property values down.

Kevin:  So what is the answer, Michael?

Michael:  I think one of the answers is property investors are probably not the threat that the Reserve Bank expects.

Interestingly, in the recent financial stability review, they came out showing that most property investors have reasonably comfortable loan-to-value ratios.

In general, they’re from an older demographic of people who have got good jobs and good cash flows, and they’re really not at risk.

In fact, many property investors are ahead in their mortgage payments. I know some people are saying, “Well, just let the market run the course. Don’t interfere.”

But we also know from our history in the past that if you do that, there are probably going to be highs and lows, and we don’t want another crash.

house price dropYou asked me what the answer is. I’m not qualified. The experts and authorities aren’t sure. The economists can’t work it out.

However, probably a mixture of something like allowing the right type of properties, ones that are sought by a wide demographic of people, to be built in the right locations, because we’ve got a shortage of the right properties in the right locations.

And then, we still have to enforce prudential banking controls and not allow people to overly speculate. I think the other measure is probably keeping interest rates appropriately calibrated, and then just allow the market to do its thing.

Kevin:  We’re in for interesting times, Michael.

Michael:  Yes, we are, Kevin.

Kevin:  Indeed. If you’d like a bit of independent advice like what we’ve just given you then, you can always contact Michael and his team at Metropole Property Strategists. Michael, thanks for your time.

Michael:  My pleasure, Kevin.


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