RBA sees Chinese and Australian apartments risks to financial stability: ANZ

GUEST OBSERVER

 

Financial stability has become more important to the RBA, with an increased emphasis on financial stability in the updated policy agreement with the Treasurer.

 

In the Financial Stability Review, the RBA is more worried about the rapid growth in the already high level of debt in China, where our recent analysis highlights the downside risk this poses to Australia’s outlook.

The RBA thinks local banks are in good shape, where household-related risks have “lessened a little” since April. The RBA thinks risks have increased for property development, particularly given the huge increase in the supply of apartments in Brisbane and Melbourne, and mining-related areas.

The main points from the Financial Stability Review were:

China’s high and rapidly rising debt is a key concern.

 

The “potential for a disruptive adjustment in China remains pronounced, given the ongoing increase in debt [is occurring] at a time when the pace of economic growth has [slowed]”. The financial system has become “increasingly large, opaque and interconnected” and easier policy aimed at stabilising the economy has fuelled the rapid growth in debt. China still has policy options to boost growth, but many of these would likely boost debt further, which “could increase the risks to longer-term reform and stability”.

European and Japanese banks remain under pressure.

 

European banks are struggling given low profits, bad debts, and weak stock prices. Low/negative rates are pressuring net interest margins for banks in Japan and other advanced economies.

Australian banks are performing well and remain “resilient to possible shocks”. Local banks have high capital and leverage ratios and have strengthened their liquidity positions. Banks have scaled back some international exposures and their exposure to the mining-related sector is small and falling (Asian bank balance sheets are the ones most exposed to mining and commercial property). Bad debts are up from low levels, mainly reflecting lending to households and companies in mining areas and the New Zealand dairy sector.

Risks related to households have “lessened a little” since April given improved serviceability metrics, tighter lending standards, and slower growth in credit. Even so, the RBA notes that: 1) house prices are up “a little” in recent months in Sydney and Melbourne; 2) the ratio of debt to income is up; and 3) non-performing home loans have increased in mining areas, which are a small part of bank mortgage books.

Local risks are centred on property development and mining areas.

The risks relate to: 1) the huge increase in the supply of apartments in Brisbane and Melbourne over the next couple of years; and 2) the search for yield boosting Sydney and Melbourne commercial property, and resource-related weakness in Perth and Brisbane.

For apartments, there are signs of longer settlement times and valuations falling below contract prices, while developers expect settlement failures will increase. Assessing the health of developers is hard because of the importance of unlisted and foreign developers.

Banks have tightened up on: 1) lending to borrowers who rely on foreign income, which may weigh on demand in the short term; and 2) property developers, which could help forestall future oversupply, although some developers are turning to non-banks. For commercial property, the RBA is worried that the current low level of yields may prove unsustainable if global interest rates rise and/or foreign demand declines.

The RBA also notes that APRA is reviewing bank commercial property lending practices, including for residential development, with the aim of improving lending standards. 

Kieran Davies is an economist for ANZ and can be contacted here.