Transcript of Question & Answer Session Panel participation at the Where to from here? - Briefing hosted by Lander & Rogers and Westpac


So, I firstly invite Michele, to share her thoughts with us.

Michele Bullock

Thank you. And thank you to Lander & Rogers for inviting me here today. I enjoyed Bill's presentation very much, and some of what I talk about here will build a little bit on what Bill said. I'm going to focus on the area that I'm interested in, which is financial stability. So it's not so much the average, or the central tendency of what we think is going to happen, it's more about the tail. What might happen. What are the things that worry me? What might keep me awake at night? In the financial stability area, an area that Bill highlighted was housing prices. But I am not worried about housing prices per se, but really debt, household debt.

So why am I worried about that? Well the Reserve Bank has a mandate for looking at financial stability. We've sort of always had this mandate. It was most obvious when we were responsible for supervision of the banks. From 1998 we no longer supervised the banks. That's the job of the Australian Prudential Regulation Authority, but we did retain responsibility for overall financial stability.

So what does that mean? Around the world there are different definitions of this. The way we think about it is trying to ensure that financial disturbances don't ultimately threaten the health of the economy. So it's not just about the health of banks, the financial institutions, it's actually about the human side of things as well. There can be really big human costs of financial instability, and that's exactly what we observed in the global financial crisis.

So I'm going to talk a little bit about just two aspects of the financial stability that we're looking at at the moment. One is the resilience of the financial system, or the banks more specifically, and the second is the resilience of households.

First of all, a little bit about the financial institutions. So as we know from the global financial crisis, if banks aren't resilient to losses, they can have a really dramatic impact on the economy. That's really, really obvious, particularly in North America and in Europe. The banks grease the wheels of economic growth. They provide credit, they facilitate payments, and they transform short-term funding into longer term assets, and in doing all of this, they take on risks. Now in normal in times, they might make some losses in some of these things. That's the nature of taking risks, you might make some losses. But supervision, by the Prudential Regulation Authority, and regulation, aim to ensure that the banks are sufficiently well capitalised; that in adverse times they can withstand some of these shocks and that their risk-management practises are robust, so that they're weighing the risks and the uncertainties appropriately.

So Australia's financial institutions, they weathered the global financial crisis pretty well. They were helped, of course, by the strength of the Australian economy. At the time, we had a resources boom going on, a terms of trade rise and a large increase in income. But they were also very well capitalised relative to some other banks overseas. And they also didn't take on, to the same extent, some of the risky practises that other institutions overseas took on during that time.

Over the past decade, after that particularly adverse shock in the global financial crisis, there's been quite a few changes internationally. You might have heard of an organisation called the Financial Stability Board, they've been very focused on what can be done to try and stabilise, and make the financial institutions around the world more resilient. There's also been standard-setting bodies, one of the most prominent being the Basel Committee on Banking Supervision. They've been working to try and make the financial system more resistant globally, and Australia has come along with that process. The Australian Prudential Regulation Authority has worked to strengthen the resilience of the Australian banks, and capital has been rising in the Australian banks over that period. They're pretty strongly capitalised now. They're probably in around the top quartile of banks internationally in terms of capital and APRA is increasingly taking an even more prominent oversight role. They look at the risks that the banks are taking on.

I think a recent example is one that Bill drew your attention to in his presentation, which is what they've been doing with what are loosely called macro prudential policies. They've been focusing on housing lending, and in particular, investment lending, lending for investors to invest in housing.

In 2014, as Bill highlighted, lending to housing investors by the major banks was rising very very sharply. And this was an environment where house prices were also rising in Sydney and Melbourne in particular, by around about 20% per year, and that was evident on Bill's graph. At that time, I think the Council of Financial Regulators, of which the Bank is a member, and also APRA, ASIC and the Treasury, they viewed this as increasing systemic risk. This was an issue about risk to the system. It was possibly exacerbating speculative demand, particularly for new apartments and all banks were increasing their exposures to housing. So this meant that if the market turned down, all banks would be affected.

There was a question here about the risk to the system as a whole. At that time, APRA put a speed limit, if you like, on investor lending, and said that banks couldn't increase their lending to investors by more than 10% per annum. And that had, as Bill showed, a very definite effect. Groth in lending to investors declined, it was only growing then by about 5% per annum. House price growth also declined. But then at the beginning of this year, things picked up again. Growth inending to investors picked up again, growth in house prices picked up again; particularly in Sydney and Melbourne.

There was another feature about this as well, and that was that a substantial proportion of this lending for investors was interest-only loans. So these are loans where borrowers actually don't accumulate equity. They just basically pay the interest. So this is a riskier type of lending, because people aren't actually reducing their loan to valuation ratios in these circumstances. So again, with the support of the Bank and the Council of Financial Regulators a further set of macro prudential policies were put in place and this involved tightening the guidance on the 10% speed limit and making it more obvious that it was expected to be met.

The second thing was that, they did a few other things, but importantly what they did is they said that no more that 30% of new loans could be interest-only loans. The purpose of these measures really was to bolster the lending quality of the banks, so that the assets that they held in these mortgages were actually well secured and that the lending was prudent. And it also addressed this concern, from a financial stability perspective, that investors might be introducing more risk by exacerbating cycles in house prices. So if investors are chasing capital gains, they might be spurred on by rising house prices, and then if any slowdown occurs that could affect sentiment, they could do the same on the downside. So they might be pro-cyclical in this sense. It's not their home, so they're not going to be desperate to hang on to it. If house prices start to decline they might just get rid of it and this is reinforced if really their focus is on capital gains.

So if this sort of behaviour takes hold, there's a risk that property prices might decline. and that will affect not just investors. That will affect all owner/occupiers, that are sitting in these homes and as we'll come to in a minute, these owner/occupiers often have high debt. They've taken on high debt, and they might end up in a situation too, where the value of their property is worth less than the debt that they have on that property. And they're having to continue to service this debt. So I guess the point I want to make here is that house prices per se isn't the issue. It's rather what the house price growth might be reflecting in behaviours, and introducing risk in the sorts of debt, and the sorts of behaviours that people are taking on.

Which leads me to the other side, which is household resilience. So even if the banks have solid capital, and they've got well secured loans, households have really high debt at the moment and that's driven largely by borrowing for housing. The households might have stretched themselves a little bit to get on the property ladder, and we all hear stories about particularly first home buyers. And at the same time, and again as Bill highlighted, incomes aren't rising very quickly at the moment. So you've got rising debt, rising quite quickly because house prices are rising. People are having to take on more debt but their incomes aren't rising as quickly. So the debt-to-income ratio is actually rising. The aggregate mortgage-debt-to-income ratio is around about 150%. Which is as high as it's really been in Australia, and for some households it's actually much, much higher than this.

Now at the moment, the debt servicing of this is actually supported by the fact that we have very low interest rates. But what happens if interest rates start to rise in this circumstance? It partly depends on why interest rates are rising. If interest rates start to rise because economic conditions have improved, employment is rising, wages are rising, things are looking good, then this mightn't necessarily cause difficulties for households. They might still be able to service these debts. There are a few other factors that give you a little bit of confidence here. Firstly as part of the improved lending standards that APRA introduced, they have actually required banks to put in, what are effectively, interest rate buffers. So they're assessing serviceability, not on the current interest rate people are paying, but on the interest rate with a buffer in it. So about 7%, as opposed about 4%. If the banks have been applying these standards with higher buffer interest rates, then households might have a bit of resilience to increases in interest rates.

We also know that a lot of households hold buffers - they hold offset accounts, they hold redraw facilities. So they've got a little bit of flex about how much they're paying, and if interest rates were to rise a bit, they can perhaps use up some of those buffers. Finally, we also know that the average debt is high, but we also know that a lot of the debt is held by high-income households. That also gives us a little bit of confidence. But nevertheless, with my worry-hat on, high levels of debt does leave households vulnerable to shocks. As Bill already mentioned, when interest rates do start to rise in Australia, they are likely to impact consumption in a different way than they did when we were in a low-debt society. So this is something that the Reserve Bank will need to take into account.

So APRA's measures have helped make the banks more resilient, they're also at the margin helping making households more resilient. But for us, at the Bank, this is just one issue that we still remain very focused on, because the high leverage in the household sector does introduce a vulnerability.

Just to sum up, I'd like to reiterate that a core focus of our financial stability focus at the Bank remains on the high level of household debt, and that debt has been encouraged by rising house prices and low interest rates. But we're looking to mitigate some of those high-risk lending areas with some of the measures that I've talked about earlier. The idea is to try and make the institutions and the households, tmore resilient to changes in circumstances. Thank you.


That's great. Thanks Michele.

Chris Anstey, Bloomberg

This is a question for Michele. I wonder what you make of Bill's characterisation of developed nations' central banks having shifted their focus, from consumer-inflation to asset-price cycles. To what extent do you think that shift has taken place? Does it differ among central banks? And do you anticipate we'll be hearing more explicitly from central banks about this shift?

Michele Bullock

Sure. So this is sort of a little bit of an ongoing debate internationally. There's one side of the argument, which is typically attributed to the Bank for International Settlements, which sort of says, in setting interest rates, you should take into account financial stability considerations. Things like asset prices, and so on.

There's another side of the debate, which is typically associated with an ex-Deputy Governor of the Swedish Central Bank, but there's others as well. This argument says no, inflation targeting is the way to go, and the way you address financial stability considerations is by using the types of macro prudential policies that we've been talking about. And in fact, a lot of countries have started to increasingly use these sorts of macro prudential policies, including Canada, including New Zealand, including Sweden. I wouldn't be quite as firm as Bill on this. I don't think that the shift is as obvious as that. I think there is still a bit of an active debate internationally on this issue. I think our Governor is on the record as saying that these sorts of things - asset prices and financial stability considerations - are things we need to consider in our medium-term flexible inflation targeting arrangements.

Other countries have less flexibility. I understand for example that in Sweden they have a very firm inflation target and so there's not as much flexibility for them to sort of take a bit longer perhaps to get back to their inflation target. I'd say there's still debate going on in this area, and I think that particularly the academic literature has a role to play in bringing to light the relative benefits of moving away from inflation targeting, perhaps and considering a bit more of the financial stability side. Not resolved yet.


Are there any other questions? I have one for you Michele, Bill spoke about shadow banking being something that has come into this market with more prevalence in recent times, given the banks pull back, in terms of lending; is that something that worries the RBA, the growth of that particular shadow banking situation in Australia?

Michele Bullock

It's grown a little bit. The shadow-banking sector in Australia was much bigger before the global financial crisis, and then basically what happened was that funding became much more expensive for these lenders. It decreased a lot and it accounts now, and I'm looking at mortgage lending really here, but it accounts for maybe 4% or 5% of mortgage lending. It's rising slightly. But there are still constraints on the extent to which they can grow. A big one of those is the availability of bank warehouse funding facilities for them, and APRA's got their eye on that. At the moment we're not seeing a massive growth in that area. But it is something we have our eye on because as we know, once you start putting constraints on one area, like the balloon, it tends to move into another area. I take Bill's point, and it is something we are keeping an eye on.


Dave Fabian.

David Fabian, Ganellen

Thanks very much to all the panellists, really interesting presentations. Thank you. A question to the panel generally, housing affordability is generating a lot of political angst around Australia at present. It seems to me that the only way to make housing more affordable, is to find a way to change the pricing structure. The risk, of course, is impact on those who do have houses, and do have debts. So is there a policy strategy which allows us to have our cake and eat it too? It seems to me, simplistically, maybe there's some kind of government subsidy intervention, or something of that nature that would be needed to cut the Gordian knot, but I'm obviously interested in the panel's views. Thank you.

Michele Bullock

Do you want to have first go?


No, you.

Michele Bullock



I want to hear what you've got to say.

Michele Bullock

Well I'm going to be suitably circumspect. The first point I'd make, and Bill made it I thought in his presentation as well, is that the housing price rises and affordability issues are particularly acute in Melbourne and Sydney. I think there's a very important thing that's going on there, and that is that the supply/demand mix is difficult. So in Sydney we had a long period of under-build. We've tried to catch up some of that, but there's still arguably a bit of a supply/demand imbalance.

In Melbourne, they've done a lot of work on that as well. They've got strong population growth though, so they've got more demand coming in. I think really the ultimate answer to this is supply, and particularly in Sydney, there are constraints on supply. Better infrastructure might assist, transport infrastructure in particular in that area. I think it's probably better to try and think of ways in which supply issues can be addressed in those markets. Than necessarily working on the demand side, because a lot of the things you were talking about, subsidies and these sorts of things, they tend to work on the demand side. I think a bit of a focus on the supply side would be more useful, but it's also a longer-term response.


Carolyn, you're a developer. Is there anything on the supply side that – I know you're in shopping centres, but you need the people from housing.


Yeah, well after I saw Bill's presentation I was really happy I wasn't in residential development, that was for sure. The housing affordability thing, right across Australia, particularly in Melbourne and Sydney is an issue that's been coming for 10 years, and it's kind of reaching some pretty critical points. To the extent that I think Property Council's data would say, controversially or not, we can accept it or not, would be that this will be the first generation of people ever to have lived in this country, who, if you do not currently own real estate, and you're not going to inherit it directly, that you will never own real estate.

So for a country that's founded on lots of people who had nothing but they could earn an average wage, and ultimately end up with equity in their own home, and retire almost as self-funded retirees, with a little bit of support from the government. That is a major shift in the social fabric of how we're going to live. And we're seeing families funding their children into homes, and all that kind of stuff, and that will become much more normal. As will, I think the concept of multi-generational families sharing either the one block of land, and developing it in a way that means the whole family can live there. You know mum, dad, grandma, grandpa, the kids as well, or what that means.

So I think that extent of change is the way that we are sort of band-aiding a solution of people being able to get access to the market and there's a range of others. I know in Melbourne we have a reasonably interventionist government, that is looking at all of those policy settings that are driving the supply side, to understand land zoning, and how does that encourage developers to try and produce different form of housing, including more affordable housing for that part of the market, where we're seeing some failure. But yeah, I agree, the concept that it needs to happen on the supply side, more than the demand side is the only way that I think we'll see that sustainable shift in us having universal access to housing.


Let me just add that obviously we all agree that it's on the supply side that the adjustment should be occurring, and the general feeling is that progress amongst the councils has not been very good and so the freeing up of more supply with maybe the amalgamation of councils etc just hasn't happened and that's a disappointment for Sydney.