Will APRA turn the screws on credit restrictions?

While the past few months have seen APRA loosen its restrictions on lending somewhat, an improvement in the property market, particularly in Sydney and Melbourne, is likely to see a rise in investors.

And this might be all the banking regulator, Australian Prudential Regulation Authority (APRA), needs to return to stricter conditions for lenders.

APRA is watching the housing market closely, particularly given ultra-low interest rates, high household debt and clear signs of revival in borrowing for speculative purposes.

It should be noted that strong investor activity is often perceived by the RBA as ‘speculation’ that increases the risk to the financial stability.

Consequently, it could spark the reintroduction of macroprudential measures by APRA.

One of APRA’s major objectives is to maintain financial resilience and stability.

APRA requires ADIs to preserve high lending standards to ensure they are effectively managing risk when issuing new housing loans to borrowers.

When a borrower applies for a housing loan, APRA requires the ADI to assess the borrower’s ability to repay the loan, accounting for the borrower’s other debt commitments and expenses.

In 2014, APRA introduced a 10 per cent limit on annual growth in loans to property investors and, in 2017, a 30 per cent limit on interest-only loans as a proportion of new lending.

Overall, APRA's stated objectives have been achieved.

Earlier this year APRA self-assessed its macroprudential policies commenting its intervention had prompted a sustained reduction in higher risk forms of lending, strengthened lending standards and reduced a build-up of systemic risk in residential mortgage lending.

It also states potentially speculative lending for property investment has been significantly reduced as has the proportion of interest-only loans.

However, household debt has reached a record high (more than double annual income, according to research from NAB) and wage growth remains low at 2.2 per cent, while property prices are slowly making a comeback.

And this has sparked debate as to whether the RBA will yet again lower interest rates next month (the most recent one being in October) to 0.5 per cent.

The Sydney and Melbourne property markets were making a strong comeback with auction clearance rates largely above 70 per cent and buyer sentiment in relation to housing measures noticeably improving with these markets likely to reach a new peak by the end of 2020.

However, he said this also led to issues of housing affordability and undersupply of family-suitable properties especially relative to population growth, which was strong in both the capital cities, particularly Melbourne.

A sustained period of ultra-low interest rates as we have seen and, consequently, a significant increase in housing finance, is highly likely to see a rise in investor activity.

Sydney and Melbourne have the largest concentration of investors and an increase in their activity will have a major impact on dwelling prices.

So, if increased investor activity contributes to double digit growth, this will mean it is highly likely APRA will be forced to consider the reintroduction of further macroprudential measures.

While it's hard to project the specific measures that APRA might implement, it is highly likely that those measures will be applied on borrowing for speculative purposes.

In other words, speculative and high-risk property investments.

Potential measures could include a more targeted approach in relation to earnings and serviceability of loans.

Obviously, APRA can once again use its previous approach of setting a speed limit on credit growth for property investors.

In addition, APRA might also set higher capital requirements for the banks.

While unlikely but still possible, another potential measure would be setting a higher buffer for the assessment rate of home loans, particularly if the RBA cuts rate again.

Currently, banks and lenders have the new 2.5 per cent buffer rate and are permitted by APRA to set their own assessment rate. Most lenders are setting a new ‘floor’, or serviceability, rate of around 5.25 to 5.75 per cent.

In the past lenders had to use a buffer rate of at least 2 per cent and had to assess at a minimum of 7 per cent.

This means ultra-low interest rates could lead to a very low 'floor' and this might be used by APRA, even temporarily, as a potential measure to reduce credit growth.

About Doron Peleg is the CEO/Founder of RiseWise Property Review. He has more than 20 years’ experience in risk management including, Co-Founder of Peleg, Kessel & Co, an assurance and advisory accounting firm & Executive Manager at Westpac Banking Corporation in Sydney. www.riskwiseproperty.com.au/