Transcript of Question & Answer Session Property, Debt and Financial Stability

Thanks Michele. So I'm not sure whether that's as positive as we were kind of hoping it would be. So we're just going to explore that a little bit further and then we'll open up to the floor for some more questions. So we know that consumer sentiment plays a critical role in the housing market especially around taxation policy including negative gearing and capital gains tax. So what's the RBA's view on the impact of potential changes around negative gearing and capital gains tax on the housing market? Assuming that we have a change of government of course, in May.

This is a question that crops up quite a lot and I think the answer is probably slightly more complex than is sometimes presented. There is no doubt that the current taxation arrangements for investor housing, negative gearing and discount on capital gains are an incentive for investors in residential real estate. And I think we've seen that. I presented some graphs on growth in investor lending and that's partly reflecting that. But it's not the only thing that is reflecting growth in residential real estate. Population growth has been a really important part of it as well. At the margin there has been, certainly in places like Sydney and Melbourne, foreign interest in real estate as well and interest rates have been very low. So that makes serviceability much easier for not only investors but owner occupiers as well.

So if you did have a change in taxation policy, it will reduce some of the incentives to investors in real estate, but that wouldn't necessarily be the end of the story. Because as housing prices come down, you will find that people who are renting might find it all of a sudden feasible to purchase. So they might add to demand. Population growth again, into some of these areas will assist. Really, what it comes down to in the end in the property market is the fundamentals of demand and supply. I hope what I showed in terms of some of those graphs was that, although it takes a while to work through, ultimately supply and demand for housing will reassert its fundamental role here. If you've got strong population growth and low growth in supply, ultimately that will catch up with you and vice versa.

So I think other studies have suggested that there might be a slight decline in housing prices from taxation. But I guess what I would say is there are many other factors underlying the housing market which have an equally big impact.

So what we've been seeing in WA in the last couple of years at least and more so probably in the last 12 to 18 months is increasing difficulty, particularly in the first home buyer segment being able to get finance. Thankfully over here we have Keystart, which has been an enormous assistance. But there are still a lot of buyers out there that are not able to get finance and in the instance that they do get finance, quite a lot of them are falling over at the valuation stage. So I reference back to Jonathan Payne who referred to credit as the oxygen of real estate. We know that credit supply is tight and like you spoke about today, so outside interest rates, what other levers does the RBA have in order to influence a maintain flow of credit particularly to those on lower to moderate incomes?

So you said outside of interest rates. Well, the Reserve Bank has one interest rate tool, which is the cash rate and that's obviously used for monetary policy and it's for the economy as a whole. Other tools we have … I'd have to say our biggest, our most potent tool potentially is this, talking, telling people … talking to banks, asking them to not tighten up the supply of credit too much. And you will have seen a lot of that recently. You'll have seen a lot of our publications, a lot of speeches, a lot of talk from the Reserve Bank encouraging the banks not to tighten up too much. I'll go back to something I said in the speech and that was that some tightening in lending standards was appropriate. Debt was very high. There was a large amount of loans which were interest-only loans and high-loan-to-valuation loans. These are more risky and it was appropriate that there was some tightening in this area.

But we're well aware that we don't want things to tighten up too much and certainly, there have been concerns … So we are out there telling banks and asking banks to tell their frontline lending staff: "Don't be too stingy here."

I think we might echo those sentiments. So in terms of given WA is such a historically and still to this day quite heavily reliant on the mining and resources sector. If we talk about China for a moment and because they play such a big part in the economic outlook, can you tell us more about the risks that a slower growth that we're seeing at the moment in China poses to us here in WA and more broadly in Australia?

Good question and it's an issue that we have highlighted in our Financial Stability Review over the past few years. I might just make a point right up front about the difference between thinking about monetary policy and financial stability. Monetary policy is interested in the most likely path for the economy and the best setting of interest rates to achieve an inflation target. In financial stability, we're interested in the tail risks, we're interested in the things that could go badly wrong. So when we think about China from a financial stability perspective, we are worried about what things could bring China quite badly undone, affect our economy and hence the balance sheets of banks and financial institutions or households and of businesses.

So having said that, we don't have many financial links with China. The banks themselves don't lend a lot in China. So there's not a direct financial link. But there is a link obviously as you have highlighted particularly to Western Australia through the Chinese economy and the growth of the Chinese economy. The risk that's been there for a while in China has been very high debt. Interestingly not household debt as in our case, but corporate debt. Corporate debt in China is well over 200% of GDP and it is much higher than any other country of a similar stage of development. And one of the concerns about this is this rise in debt has been driven by the non-regulated financial sector, by non-banks. But the problem is that the banks have helped finance those non-banks and there is a concern that in doing all this lending, they've taken risks and that, that will eventually flow back to the banks and the banks will find themselves in financial difficulties.

And I don't know of any economy that's had a financial crisis that doesn't ultimately have an economic crisis as well and that's the risk for Australia for, the financial stability risk, if you like. That financial instability in China driven by their very high debt levels, their lending by non-bank financial institutions that haven't been heavily regulated, that will flow onto the economy. And at the moment this is in fact the issue that the Chinese authorities are dealing with. They are trying to wind back these financial stability risks by reigning in the lending by the non-banks but at the same time they're still trying to keep their growth up and this is a very much a balancing act for the Chinese authorities at the moment. We hope that it comes out well, I'm sure you hope that it comes out well. But at the moment that is one of our biggest external challenges.

I'm going to open it up to the floor in a moment. So if you can all start thinking about some of the questions that you want to ask Michele. You mentioned that high household debt coupled with housing price downturn has heightened risk in terms of financial stability. How much more will house prices have to fall before it becomes a full-blown issue?

Ah, yes. Everyone wants a number. I wouldn't like to hazard a number but let me give you some context. I mentioned earlier that we've managed to get high-loan-to-valuation ratio loans wound back and also that many households don't borrow the maximum amount that they were eligible to borrow. People who purchased a house right at the very peak, say in Sydney or Melbourne, and had a very high-loan-to-valuation ratio would be feeling the squeeze. There is no doubt about that. But at least on the numbers that we have and the estimates we have, most people, because housing prices went so high, most people purchased well before that peak and they purchased with a loan-to-valuation ratio less than 80%, and they didn't necessarily borrow the maximum amount they could. So what that suggests to me is that the fall so far actually isn't big enough to produce a very big change and stress in household balance sheets or bank balance sheets because the loans are still well secured.

But it depends very much on the next year and if we see continued sharp falls, then you will start to see potentially more stress on households. I want to qualify that though with the point that owner occupiers typically … If the value of my house, for example, has fallen below what I paid for it, that's not a concern for me unless I am distressed and trying to get out. Usually the house is providing me with housing services. I'm living in it, I'm not renting. So the risk isn't so big for those who are owner occupiers, who have jobs and while employment is growing and unemployment is low, those people can continue to meet their repayments and there's not so much risk there. The concern more is that if housing prices fall much further and much faster in the next year or so, then some investors and those whose circumstance has changed, they might find it difficult. So again with my financial stability hat on, these are the things I would be watching for.

Thanks Michele. I'm going to open up to the floor now for any questions for Michele.

(Off microphone) Hi Michele, thank you very much for that. In Western Australia, although you're talking to the banks up to giving more credit, we've had the Royal Commission and APRA tightening credit standards. Developers are reporting that as much as 50% of contracts are falling over, these aren't investors, these are owner occupiers looking to buy a house and expecting to be able to get a loan and simply not able to get a loan. Have those credit standards tightened up too much, and is there anything that could be done to try and free up credit a little bit more, particularly in Western Australia …

Lett me say that I understand that conditions in Western Australia have in fact as you highlighted, been more difficult than in other areas and I don't have specific intelligence on how the banks are reacting in Western Australia, but in those circumstances, banks tend to be a little bit pro-cyclical. They tend to tighten when things are going down and they tend to have lots of largess when things are going up. So my main point would be the same one I made earlier. We are out there encouraging banks to lend to good credit risks and there are some signs that they are doing so. Interest rates that are being charged to new borrowers who are good credit risks are actually lower than outstanding interest rates. So there are some suggestions that there's competition for good borrowers. I would hazard a guess that if there are some green shoots appearing in Western Australia that there is a little bit more population growth, that the oversupply that that had come about post-mining boom has started to ease, that you might hopefully see banks starting to realise that.

But it is an issue that banks tend to be a little pro-cyclical. So my job here, the Governor's job, others is to basically encourage banks to look at people, look at the good credit risks and make sure that you are granting credit. As I said in my speech, zero credit risk is not the goal here. Zero-credit losses are not the goal. If banks are having zero-credit losses, they are not doing their job properly. They should be taking some risks.

Any other questions from the floors? One at the back there.

Very interesting and I'll pick up from where David was coming from before. We are unfortunately affected by Melbourne and Sydney and just listening to you today, it's Melbourne and Sydney, and we forget about Western Australia and sometimes we don't even think we exist over here in the big picture. But we've got a really unique situation now where the vacancy rate running at about 2.6, or almost negative. We've got no investors entering the market because they can't afford or they can't get the funds to carry through in that investment and we're getting first home buyers, as Tony was talking about, can't get finance. So that's putting stress back into the rental market. So that's going to have an effect. Now the law of supply and demand. Okay, fundamental. But when you can't get credit, you can't get supply. So I don't know how that gets resolved. I'd like to hear how you can answer that one. Thank you.

I absolutely get it. And it's a very difficult situation and I don't know the answer to it, the Reserve Bank doesn't have any tools that we can force banks to lend. My hope is that now that the Royal Commission has finished and that APRA has finished and it's removed its benchmarks and banks are gradually coming off those, that banks will start to lend again. This this is their business. So I have no silver bullet unfortunately. I feel your pain and I do understand your concern that the focus is Melbourne and Sydney, and Western Australia and Perth are … I can reassure you though that we do look at Perth. Perth is always one of my four panels on my four panel graphs. I have no silver bullet for you, I have no solution. All I can do and all the Reserve Bank can do is continue to encourage the banks. And I don't know if there are any bankers here today, I think there's at least one. Please think very hard about whether or not your lending standards are too tight and whether you can loosen up a bit.

Do we have any banks in the room that would like to counteract that comment? Anyone that's willing to speak? No? Okay, we have a question right at the back there.

Do you think that some of this risk aversity particularly in the market is still a hangover of the GFC?

In our case, no, I don't really think so. The Australian banks came through the GFC very well. They were well capitalised, they didn't have the same issues with investments that many of the banks overseas had. And since that time, if anything, they have expanded voraciously into residential lending. The balance sheets of the Australian banks are so heavily weighted towards housing, which as I was mentioning earlier has its own systemic risk, because if something goes wrong in the housing market, it affects all of the banks, not just one bank. So I don't think it is a hangover from that. I think a few things have gone out. As I mentioned, I think APRA asked banks to tighten, justifiably. In fact, if you look at it, the data looks very much like - and in our Financial Stability Review, I should say we did a little bit of work on this.

The data suggests that in fact what was happening through that big run up in the eastern states I admit, was that owner occupiers were being crowded out by investors. That's what was happening and what we've seen now is that investors' growth is coming off and owner occupiers and first home buyers are able to get back in. So that was one part of it. I think the Royal Commission has affected the mindset of the banks and in particular the frontline staff. I hear anecdotes of frontline staff saying: "Well look, I was watching the Royal Commission. I saw someone up there that looked like they were in a similar position to me getting dragged over the coals. I don't want to go there." So I think that has been more of an impact than some sort of hangover to the GFC. And I'm hopeful back to the earlier question that now the Royal Commission is out of the way, APRA has removed its various benchmarks, banks now can concentrate on thinking: "Well, have I tightened up too much at the margin? Do I need to think a little bit more carefully about this?"

Another question just down here.

WA really is the export powerhouse of the Australia nation. We've danced to our own tune for more than a decade. If you look back when the eastern states are booming, we've had trouble, when they're having trouble, we're booming. Do you have any tools at all for use on individual states?

From the Reserve Bank's perspective, we've got one tool and it's an interest rate. And so unfortunately my answer is no, in this sense. We have one tool, it's an interest rate and everyone around here would understand that … the Reserve Bank can't set a different interest rate for different states. It doesn't work that way. And this isn't my area of expertise at all, but this is where government policies and so on have an impact. The Reserve Bank itself doesn't have anything that can work differently for different states. We've got to take a national view as far as setting an interest rate goes.

So just following on from that, our state government decided that it was a good time to implement foreign surcharge on investors. Experience from the eastern states, which have all had these taxes in place for quite some time, our unique selling proposition I suppose for WA, attracting particularly Asian investors to the state has now disappeared. What are your thoughts on what impact you think that will have from an investor perspective?

So the issue of foreign taxes, this isn't just an Australian phenomena I should say. There's been a number of other countries around the world which have put on similar taxes. Canada and New Zealand in fact implement it on particular cities. So this concern that foreign investment was driving up the prices has been a concern not only in Australia but in other countries as well. My general observation would be that in periods of very strong growth in property markets, it might help a little bit to take the edge off. But in fact, we feel that in terms of foreign buying, what's had more impact than the taxes has been Chinese government restrictions on outflows from China. That's been at the margin more of an impact then the taxes have had.

It also depends very much on why people are purchasing. If foreign investors are coming in to purchase for their child to go to university for example and live here or just because they want to have a residence somewhere else, a bit of a safe haven. I think there's a question about how big the taxes have to be before you dissuade that sort of thing. And some of the experiences overseas, particularly in Canada, they've found it very difficult even with taxes to keep prices from rising. I have no particular inside knowledge on your state government's decision to do that. I would only observe that given the market was not particularly buoyant to begin with, putting a tax on it wouldn't seem to help that circumstance.

You wouldn't have thought so. No. Question down the front.

Given the reliance on monetary policy, do you think that governments have abrogated their responsibilities around fiscal and taxes and charges to the state of the economy to the RBA?

I'm trying to think if there's a financial stability lens on that. I wouldn't like to hazard an answer at that. The Reserve Bank does what the Reserve Bank does, which is, in monetary policies it's a very specific role, which is to set an interest rate to meet an inflation target, taking into account financial stability, taking into account employment, the state of the economy. We do a number of other things as well actually but everyone seems to focus on monetary policy. All I can say is our focus is on doing what we are mandated to do and we do it to the best of our ability and it's up to the governments to do what they do to the best of theirs.

Good answer. One of the other things that I was particularly interested in as one of the outcomes of the Royal Commission was a regulator for the regulator. I'm not sure how many regulators a regulator needs. How do you think that, that when it's implemented will have an impact on the way at APRA responds to issues?

The oversight body is not there to second guess. This is my understanding from the recommendation. It's not there to second guess the decisions that are made by the regulators. It's really there to look at their processes, look at their capabilities, understand whether they are meeting their targets and so on. I don't think it's going to change the way that the regulators go about their jobs. I think that the regulators are very professional organisations. They will continue to go about their job. They might tweak some things in response to the Royal Commission but broadly, I think that it's not going to impact really the way they go about their day to day work.

Do we have any last questions from the floor? I think you've been let off pretty lightly actually this morning. Well, please join with me in thanking Michele Bullock for her time this morning. So just before we close today, I just wanted to again, thank our sponsors for today's breakfast Parcel Property, CLE, Department of Communities and GOF. Just a quick reminder of our next industry event, which is the Challenges of Change. We have a couple of different keynote speakers talking about the importance of public participation, particularly around the density debate that we're all participating in at the moment. And we have three of our mayors from various local government authorities coming to give us their perspective as well. So it'd be great to see you all there. Other than that, I wish you a wonderful Wednesday and we hope to see you soon. Thank you.