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Lenders could be in trouble if any blowout in debt corresponds with a correction in skyrocketing prices for assets like property, the Reserve Bank of Australia has warned.
In its biannual financial stability review, published Friday, the RBA warned that the growth in asset prices, including property and equity, could lead to “over-exuberance” – riskier behaviour from borrowers or lenders and higher debt.
“In this situation lending standards could weaken, with asset prices being pushed above their fundamental values,” the report said. “A correction in asset prices, if borrowers’ income were to fall and so they defaulted on debt repayments, would expose lenders to large losses on the increased debt, particularly if the quality of that debt had been eroded.”
Risks were higher in assets like housing, where prices and debt have seen a notable uptick in recent months, The Australian reported.
Dwelling prices rose 2.6% in March, the strongest spike in more than three decades. Prices now sit at record levels.
However, regulators have no mandate to specifically target property prices. Regulatory authorities have said repeatedly that they would only step in to cool the market if banks started loosening their credit standards.
Still, the report said the RBA and other regulators were keeping a weather eye on the booming market. The central bank said that it was especially important for the financial sector to eschew “excessive risk-taking” in an environment where asset prices were skyrocketing and the cash rate remained at a record low.
Read more: RBA tips scrutiny of booming housing market
“Increased risk-taking by lenders could take the form of looser lending standards for individual loan assessments, or a relaxation of internal limits on the share of riskier loans they make,” the report said. “Even if lenders do not weaken their own settings, increased risk-taking by optimistic borrowers could see a deterioration in the average quality of new lending. This would weaken the resilience of businesses and households, and so the financial system, to future shocks. Increased risk-taking would fuel rising debt, from already high levels, increasing the debt-related risks to the economy and financial system from a fall in asset prices and borrowers’ income.”
The report also noted that the vast majority of households and businesses that deferred interest payments during the COVID-19 crisis have now resumed full repayments. Recently released data revealed that the value of deferred loans, which peaked in 2020 at $270 billion, has fallen to just $14 billion – about 0.5% of total loans, The Australian reported.
However, the RBA warned that household and business financial stress was likely to increase as COVID-19 support measures expired.
“Households and businesses that derive their incomes from sectors most heavily affected by the pandemic face an elevated risk of repayment difficulties if their buffers prove to be insufficient,” the central bank said.
Ryan Smith is currently an executive editor at Key Media, where he started as a journalist in 2013. He has since he worked his way up to managing editor and is now an executive editor. He edits content for several B2B publications across the U.S., Canada, Australia, and New Zealand. He also writes feature content for trade publications for the insurance and mortgage industries.
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