Bank bashing is one of those time-honoured, but ultimately frustrating pastimes in Australian life.
The more the banks are jabbed with accusations of unscrupulous practices, monopolistic pricing and poor service, the harder they tend to bounce back with record profits.
The banks don’t fear a lot, except perhaps recessions and rising unemployment.
Politicians – incapable or unwilling to land a blow – seem to be boxing well above their weight division when taking on the banks.
Only the Australian Prudential Regulation Authority, when roused to action, causes the banks to strike anything like a deferential pose.
APRA doesn’t come out swinging, though.
It communicates in moderate tones, often clouded in opaque financial jargon.
The regulatory thumbscrews are twisted ever so gently when APRA slips into its pale imitation of the Spanish Inquisition’s Tomas de Torquemada.
Shrieks of pain and sobbing confessions are not heard from the banks.
At worst, there is some sotto voce grumbling, but more commonly the banks publicly welcome APRA’s moves through gritted teeth, saying they will have minimal impact on the way they go about business.
APRA is not about bursting property bubbles
Lately APRA has been proselytizing more loudly and turning more screws more vigorously, but to what effect? Still no screaming or even noticeable squirming from the banks.
And why not? Firstly because the banks have to cop it, and secondly not a lot is going to change – banks will still be selling home loans and still making a decent lick of profit on them.
As a rough rule of thumb, every 10-basis-point increase in the standard variable rate of home loans adds 2-to-3 per cent to the earnings of the big banks.
That’s pretty handy, especially when waved through by the authority policing your actions.
APRA is about ensuring banks are financially sound.
Bursting property bubbles or making life comfortable for over-extended borrowers is not really in its mandate.
The first twist in the latest crusade against imprudent lending was in late-2014 when APRA placed a 10 per cent speed limit on the annual growth of investor mortgages for the big four banks.
Step two, in 2015, was to curtail the big banks ability to arbitrarily judge the riskiness of their loans themselves.
Recent research from investment bank UBS pinpoints a remarkable coincidence between banks being able to calculate their own risk on mortgages – or assign risk weights – and the exponential growth in Australian household debt.
From the time the original Basel 1 reforms were introduced in 1988, the banks leveraged their mortgage books far more heavily than other lending products and allocated a greater proportion of their book to mortgages.
Subsequent Basel reforms gave the big banks even greater leeway, allowing mortgage debt to blow out to be currently about the same size as Australia’s economic output, but growing far more rapidly.
Australian mortgage debt as a percentage of GDP has soared since banks were allowed to calculate the riskiness of their home loans (Supplied: UBS)
Sensing the danger, APRA backtracked and put a regulated floor under the so-called risk weightings, effectively stating that 25 per cent of home loans were at risk, as opposed to the roughly 16 per cent the banks previously fessed up to.
It also meant more capital had to be held against home loan portfolios.
That slowed bank earnings growth, but not so much that bank investors found somewhere else to park their money. Nor did it dry up lending to the riskier end of the property market.
More recently, APRA sharpened it focus on higher risk lending, limiting the flow of interest-only lending to 30 per cent of total housing lending – it had been running at closer to 40 per cent – and enforcing even more rigorous scrutiny of loans supported by 10 or 20 per cent deposits.
On UBS figures, cutting back interest only loans from 40 to 30 percent of new loans would reduce the flow of new mortgages by $15 billion a year and cut credit growth by around 1 per cent.
UBS bank analyst Jonathan Mott said APRA’s most recent moves were likely to constrain lending only at the edges.
“From the banks’ perspective, (a 1 per cent hit to net profit) this is manageable,” Mr Mott wrote in a note to clients.
“What is harder to gauge is the impact on the housing market ‘animal spirits’ if the marginal buyer is removed from the market.”
Lending standards improve, but household debt keeps rising
So what has that achieved?
For one thing, the latest twist has spooked shareholders, with the big four slipping around 2-to-3 per cent in the week after the most recent changes were announced.
More broadly, according to Morgan Stanley analyst Richard Wiles, APRA’s measures may have led to an improvement in lending standards, but they have failed to materially slow credit growth.
Nor have they prevented the build-up in total household debt, which now equates to more than 125 per cent of GDP and closing in on 200 per cent of disposable income.
Despite all the talk about curtailing investor lending through the introduction of a “speed limit”, not much has changed.
“Overall, investor property loan growth looks to be “comfortably” below the 10 per cent speed limit, suggesting that APRA’s latest measures are designed to prevent an acceleration of growth, rather than to materially reduce it,” Mr Wiles said.
There is a very good reason why banks will try and lend right up to APRA’s ceiling.
“There is still incentive for banks to lend to investors, as ROEs (returns on equity) on investment property loans are now about 14 percentage points higher than ROEs on owner-occupier loans, ” Mr Wiles said.
Despite expectations that a further reduction in the investor loan speed limit, APRA decided against it saying it still “needed to balance new investor lending with the increased supply of newly completed construction”.
In other words, if lowering the speed limit to say 7 per cent growth strangled investor lending, there would be serious problems clearing the looming glut of apartments building in Melbourne, Brisbane and Sydney.
A wave of deposit defaults in high rise apartments and property developers hitting the wall would do little for APRA’s cherished goal of financial stability and de-risked banks.
So there is a tacit understanding that pretty solid investor lending growth is still fine.
Up to 33pc of investment loans are high risk
The banks have been exercising their oligopolistic pricing power since the GFC, basically by holding back the full RBA cash rate cuts as standard variable home loans timidly edged down.
That so called “re-pricing” has become more pronounced and more targeted of late, with investor loans being hiked up 60 basis points, compared to the more modest 15-to-20 basis points for owner occupiers.
In effect, APRA has given the green light to the banks differential re-pricing because (a) it cools investment loans and (b) strengthens the banks’ balance sheets.
“While Reserve Bank officials are somewhat circumspect about what the measures can achieve, relative to the current state of affairs, we see these and earlier measures as likely to bind on lending activity, with a potential spill-over to housing turnover and price growth as well,” JPMorgan economist Ben Jarman said.
“It is likely that overall mortgage lending will slow, as the acceleration in non-interest only owner-occupier lending needed to offset the drags from macro-prudential tightening seems implausibly large.”
The target for APRA is what the global Basel banking committee refers to as loans that are “materially dependent” on cash flows generated by the property.
What that actually means is difficult to define, but Morgan Stanley’s Richard Wiles has had a stab at it using a recent Westpac data.
“Westpac’s disclosure highlights that around 30 per cent of investors have incomes of less than $100,000, and close to 50 per cent have more than one investment property,” Mr Wiles said.
“Where a borrower fits into both categories, we think there is a good chance that the loan could be classified as ‘materially dependent’.”
Or, in other words, somewhere between 20 and 33 per cent of Westpac’s interest-only, investor loan portfolio could be defined as “materially dependent” on cash flows.
Plugging that into the spread sheet, and factoring risk weightings that are likely to raised against these loans, Mr Wiles calculated the “big four” will need somewhere between $12 billion and $16 billion in fresh capital buffers.
Investor loan rates are likely to keep going up past 6 per cent
For the investor, if the banks were to use their oligopoly power to maintain existing healthy returns-on-equity, that would mean another round of rate hikes of about 30-to-80 basis points on their interest-only loans.
But that may the hikes for investors may be steeper than that.
“We think the major banks will respond to APRA action by lifting standard variable loan rates on investor property loans above 6 per cent,” Mr Wiles said.
“If the majors were to repeat the action of the past few weeks and increase investor loan rates by around 25 basis points, we estimate an earnings benefit of 2.5 to 3 per cent for CBA, NAB and Westpac and and 2 per cent for ANZ, ” Mr Wiles calculated.
So it is not necessarily the banks that are bleeding when the thumbscrews are tightened.
UBS’s Jonathan Mott said banks might find it difficult to raise rates on existing loans, as the recent APRA changes only apply to new lending.
“That said, the banks have shown a tendency to use policy changes as a catalyst for repricing in the past,” Mr Mott noted.
“Given limited public or political push-back against investor repricing in recent months, we believe this could be the favoured area for the banks.
“We also believe the banks may offer some first home buyer discounts to further ease public or political push-back.”
Over at Morgan Stanley, Mr Wiles pointed out, while jacking up investor loan rates helps APRA, the RBA and government achieve some of their policy goals, the authorities and banks face a difficult balancing act.
“They would help owner occupiers and first-home buyers to compete with investors, without the need for changes to legislation on negative gearing and capital gains tax concessions,” he observed.
However, there is a cost.
“Given the weak income growth in Australia, we would also expect this amount of re-pricing to have a detrimental impact on the residential property market,” Mr Wiles said.
“In our view, slower loan growth and house price weakness look increasingly likely.”