The Reserve Bank of Australia (RBA) has used its confirmation that interest rates will stay at 1.5% for the foreseeable future to forewarn of impending mortgage stresses that could have a negative effect on the economy.
Calling the problem a “ticking time bomb,” it said in a release that a series of bad choices will send Australia toward potential pitfalls sooner rather than later. These include ballooning levels of household debt that show no signs of dampening, higher rates for mortgage lending and a drop in the average house price.
When compounded by what RBA considers poor choices by banks in handing out mortgage loans with interest rates that many households would struggle to service and be at risk of defaulting on, these problems could easily unsettle the economy and send it into a tailspin.
Labeling these issues as on par with “main risks to financial stability,” RBA said that it is forecasting a rise in defaults and mortgage arrears in the next two years and that the irresponsibility from some major banks has led to a change in its corporate plan and an inability to change the interest rate.
Banks are also a high risk given their clear exposure to a potentially large number of defaults, for which they might not be able to allow financial liquidity to soak up the reduction in expected capital. RBA said that banks and regulators have to step in for “ongoing monitoring” to keep on top of the situation.
RBA will also engage in monitoring developments in relation to the “high level of household indebtedness” and closely watch the levels of mortgage lending passed onto the average household.
The major banks’ performance when it comes to mortgage lending over the last few years has been heavily scrutinized in the wake of the Royal Commission inquiry into financial misconduct across the sector. The largest home lender, Westpac, saw itself caught in the crossfire earlier this week as it faced a $35m fine for irresponsible lending.
According to the Australian Securities and Investments Commission (ASIC), Westpac had greenlit mortgage lending on some 10,500 dwellings that should never have received approval.
Dr Timo Henckel, Macroeconomist and Chair of Australian National University’s RBA Shadow Board, said that “the high leverage” currently experienced by Australian households makes it no surprise that RBA is so concerned about the stability of the Australian economy.
The mortgage market is considered the main reason for the downward push on most households, which follows familiar echoes of how it moved in the US before the global financial crisis in 2008, when too many sub-prime mortgages were handed out with the likelihood that the interests and debts would never be appropriately serviced.
Henckel said: “If Australian households get caught out, and it becomes a downward spiral,” this could lead to a storm of rising interest rates, many people having to sell their houses and a serious decrease in house prices across the board.
This, Henckel added, should not be surprising, given that a major drop in the average house price is “inevitable,” though “a serious correction” should take place down the line. The question remains of how soon this will take effect, as the longer that any correction takes, the more debt will occur.