Property investors continue to drive credit expansion and national dwelling prices, particularly in Sydney. However, there is tentative evidence that investor credit growth has started to stabilise and good reason to believe that the pace of growth may begin to ease over the second half of the year.
Outstanding housing credit rose by 0.5 per cent in May, with growth easing modestly since earlier this year, to be 7.2 per cent higher over the year. The housing sector continues to dominate bank balance sheets and recently profitability, with business lending rising by a more moderate 5.2 per cent over the past year.
Personal lending remains somewhat muted, which is fairly consistent with property markets outside Sydney and Melbourne, to be 0.8 per cent higher over the year.
The property sector can be divided into owner-occupiers and investors. There has been a sharp divergence between the two over the past couple of years.
Credit outstanding to the owner-occupier segment has increased by 5.7 per cent over the past year. Home buyers were active in the initial aftermath of the RBA’s easing cycle but growth has since moderated to a level that may exceed income growth but is considered fairly benign by our financial regulators.
By comparison, credit outstanding to property investors rose by 0.8 per cent in May and remains 10.4 per cent higher over the year. Based on the monthly trends, it appears as though investor credit growth may have peaked.
It’s not set in stone. Monthly lending activity remains elevated and interest rates are at a historically low level, but don’t be surprised if investor credit growth eases towards 10 per cent over the remainder of the year.
That’s a fairly important development because APRA has declared that “growth [in investor credit] materially above a threshold of 10 per cent will be an important risk indicator for APRA supervisors in considering the need for further action.” As it stands, most major banks have announced plans to ease up on investor lending to safeguard their business model against regulatory interference.
As a threshold though, the 10 per cent limit isn’t all that meaningful and persistent growth of that nature will inevitably lead to greater systemic risk. With nominal GDP expanding by just 1.2 per cent over the past year and forecast to remain weak in the medium-term, could APRA have justified a lower threshold?
As a general rule, the higher the stock of existing credit compared with GDP or income, the greater the potential systemic or financial risks at any given level of credit growth. In the absence of a lengthy period of deleveraging -- such as that which occurred in the United States -- the threshold at which financial risks will emerge will get lower and lower. When nominal GDP is subdued, the margin for error becomes even narrower.
Nevertheless, we also face an unavoidable fact: the Australian economy needs greater business borrowing in order to support employment and growth once mining investment collapses.
Bank lending isn’t the only way in which businesses can expand but it is often the only way in which small businesses can thrive. It’s also a significant source of financing for larger corporations (although often in the form of syndicated loans) given Australia has a largely undeveloped corporate bond market.
The aggregate data tells a fairly depressing tale. Business credit now accounts for just 33 per cent of credit outstanding -- its lowest level since at least 1976 (when the statistics were first recorded).
Most policymakers are unconcerned about this trend. Prime Minister Tony Abbott hopes that house prices continue to rise, while Treasurer Joe Hockey views elevated prices as an aspirational target for Australia’s army of renters.
But neither the property market nor the business sector operate in isolation. Developments (good and bad) in one market inevitably spill over into the other.
The business sector, for example, pays our wages, which many of us use to pay down our mortgages or finance a deposit on a new home. Meanwhile, land prices are a considerable cost for most businesses, particularly those who need floor space to sell their goods or new land to build or expand a factor.
Rapid credit growth in the housing sector and weak growth in the business sector would appear to be a recipe for disaster in the long term. It’s a key factor that explains how uncompetitive Australian businesses have become compared with our foreign-based rivals and it sits at the forefront of our recent struggles.
It’s an issue that needs to be fixed, but there have been some promising developments. Recent statements by APRA indicate it is serious about reining in investor credit. Meanwhile, APRA chairman Wayne Byres recently declared that the regulator was willing to act “sooner rather than later” to implement the higher capital requirements recommended in the financial system inquiry late last year.
But progress will be slow unless there is genuine bipartisan support for reform. The banking lobby is formidable and will naturally resist any reform that could undermine their short-term profitability. It will ultimately be a test for the Abbott government, which has stated a firm commitment towards improving economic growth but has taken few steps (outside of a modest small business package) towards achieving it.