RBA Governor Lowe takes aim at banks' lending practices and tax structure for investors

RBA Governor Philip Lowe has taken aim at banks’ lending practices and interest-only loans, while saying that in the long run only the supply of housing can address affordability. 

At a speech in Melbourne, Governor Lowe pulled up the lending practices of banks, saying “too many loans are still made where the borrower has the skinniest of income buffers after interest payments”.

“In some cases, lenders are assuming that people can live more frugally than in practice they can, leaving little buffer if things go wrong”. 

He justified the response of the Australian Prudential Regulation Authority that lenders can expect more scrutiny of loans with a very low net income surplus.

Last week, APRA clamped down on interest-only loans in a bid to cool the hot east coast property market, asking lenders to restrict interest-only loans to 30 per cent of new residential mortgage loans.

Interest-only lending represents nearly 40 per cent of residential mortgage lending by banks.

“Over the past year, close to 40 per cent of the housing loans made in Australia have not required the scheduled repayment of even one dollar of principal at least in the first years of the life of the loan; only interest payments are required. This is unusual by international standards,”  said Lowe.

“In some countries, repayment of at least some principal is required on all housing loans for the entire life of the loan. In other countries, interest-only loans are available only if the borrower has already contributed a fair degree of equity. So this is one area where Australia stands out. We are not unique in this area, but we are unusual.”

Last week, APRA Chairman Wayne Byres too had addressed the issue, saying “APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile.” 

While noting that the contrast in the housing markets of Melbourne and Sydney versus Perth and other regions, he said supply of housing hadn’t kept pace with Australia’s population growth and the result has been higher prices.

“Not surprisingly, the rising prices have encouraged people to buy residential property as an investment in the hope of ongoing capital gains,” said Lowe. 

“With global interest rates so low, many investors have found it attractive to borrow money to invest in appreciating residential property. This has reinforced the upward pressure on prices.” 

He said the rising indebtedness and rising housing prices was discussed at length by the Council of Financial Regulators because of the risk to the stability of our financial system. 

Although banks are soundly capitalised, he said the main concern was that the longer the recent trends continued, the greater the risk to the future health of the Australian economy. 

“Stretched balance sheets make for more volatility when things turn down.”

He said the flexible nature of Australian mortgages explain a high proportion of interest-only loans as also the taxation rules. 

“Many people with interest-only loans make significant payments into offset accounts rather than explicitly paying down principal. This flexibility, which is of value to many people, isn't available in most countries.

“A second factor is the taxation arrangements that apply to investment in residential property in Australia.”

APRA’s new measures restricting interest-only loans and strict limits on interest-only loans with high loan-to-valuation ratios, along with curbs on investor lending should help the whole system pull back to a more sustainable position. 

“A reduced reliance on interest-only loans in Australia would be a positive development and would help improve our resilience. With interest rates so low, now is a good time for us to move in this direction. Hopefully, the changes might encourage a few more people to think about the merit of taking out very large interest-only loans when interest rates are near historical lows.”