The RBA is worried rising household debt and property prices could present a risk to economic stability

© Provided by Business Insider Australia

  • The combination of high household debt and enormous property prices could backfire in case of another economic downturn, the Reserve Bank of Australia says.
  • In a Wednesday speech, assistant governor Michele Bullock flagged the combination “may result in vulnerabilities” to banks and households.
  • The central bank is assessing macro-prudential levers to pull in case of crisis, she said.
  • Visit Business Insider Australia’s homepage for more stories.

The Reserve Bank of Australia (RBA) says the nation’s still-rising household debt could pose a risk to financial stability, with runaway housing prices likely to backfire on homeowners and the banks should the nation face another deep recession.

In a relatively dramatic speech for the central bank, assistant governor Michele Bullock on Wednesday told the Bloomberg Inside Track conference that a “high level of debt could pose risks to the economy in the event of a shock to household incomes or a sharp decline in housing prices.”

Australia’s household debt ranks among the highest in the world. Buoyed by rising house prices, some analysts think it could reach record levels this year.

Debt-to-income ratios also remain elevated, thanks to stagnant wage growth.

Bullock held the RBA’s line that mortgage lending standards have been upheld across the banking sector, and said solid bank capitalisation could protect lenders in case of a new economic crisis.

The RBA and the Australian Prudential Regulation Authority are also monitoring debt-to-income and loan-to-valuation ratios closely, she added.

“However, while household debt to income in Australia hasn’t increased much over recent years, it is at a high level, both historically and relative to other countries,” Bullock told the conference.

“So sustained strong growth in credit in excess of income growth may result in vulnerabilities building in bank and household balance sheets.”

The central bank has envisioned a scenario where a correction to record-high housing prices corresponds with an extended loss of income for Australia’s highly leveraged households.

It is “disruptive and stressful” for owners to sell their homes under normal circumstances, Bullock said, but “at least [they are] able to repay the debt.”

“However, if the value of the home has fallen substantially since they took out the loan, they will be unable to ‘self-cure’ in this way.

“In these circumstances, banks would incur losses and if there are enough, like in the GFC, there could be a substantial impact running from households to banks.”

Other households could feed into this downward spiral, with lowered consumption leading to subdued economic activity across the board.

“Sharp declines in housing prices could result in households curbing their consumption, more so if they are highly leveraged, further exacerbating any downturn in the economy,” Bullock said.

The bank is constantly assessing what macro-prudential levers it could pull in event of emergency, she told the conference.

Methods of ensuring loan serviceability, and constraining how much debt any individual could take on, “could be employed in Australia should the circumstances be judged to warrant it.”

Such measures were flagged back in July by RBA governor Philip Lowe, before the latest round of COVID-19 lockdowns kicked in.

An interest rate hike would limit the number of new borrowers — but the RBA has already indicated it won’t bump the official interest rate from 0.10 per cent before 2024, as wage growth is a long way from reaching reserve bank targets.

The RBA’s next full Financial Stability Review will arrive in October. For now, the central bank is happy to say it’s watching closely.

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